FORECASTS & TRENDS E-LETTER
by Spencer Wright
July 9, 2024

You Can’t Build a Dollar Out Of BRICs

IN THIS ISSUE:

1. What is a Reserve Currency?

2. How Did the US Dollar Become the Global Reserve Currency?

3. Are There Any Credible Alternatives to the US Dollar?

4. Why Doesn’t the Massive US Debt Matter?

5. Final Thought

Market commentators can be heard warning of a concerted effort to “de-dollarize” the global economy. They point to the dollar’s declining usage in world trade and as a central bank reserve currency.

But is this reality or just a hyped-up myth? Today we examine why the US dollar is still the world’s reserve currency and why it will not be deposed from its top spot anytime soon.

What is a Reserve Currency?

Let’s start off with some basic definitions. What is a reserve currency? A reserve currency is a foreign currency that is held in significant quantities by central banks or other monetary authorities as part of their foreign exchange reserves. It is often considered a hard currency or safe-haven currency, used in international transactions, international investments and all aspects of the global economy. The current reserve currency in use by the entire planet is the US dollar.

Investopedia informs us of some of the specific functions of a reserve currency:

• A reserve currency reduces exchange rate risk since there's no need for a country to exchange its currency for the reserve currency to do trade.
• Reserve currency helps facilitate global transactions, including investments and international debt obligations.
• A large percentage of commodities are priced in the reserve currency, causing countries to hold this currency to pay for these goods.

There have been other reserve currencies over the past few hundred years, most notably the British Pound Sterling.

How Did the US Dollar Become the Global Reserve Currency?

Again, Investopedia provides an excellent explanation.

“The post-war emergence of the U.S. as the dominant economic power had enormous implications for the global economy. At one time, U.S. Gross Domestic Product (GDP), which is a measure of the total output of a country, represented 50% of the world’s economic output.

As a result, it made sense that the U.S. dollar would become the global currency reserve. In 1944, following the Bretton Woods Agreement, delegates from 44 nations formally agreed to adopt the U.S. dollar as an official reserve currency. Since then, other countries pegged their exchange rates to the dollar, which was convertible to gold at the time. Because the gold-backed dollar was relatively stable, it enabled other countries to stabilize their currencies.”

It was at this point the US Dollar replaced the Pound Sterling. But this was just the first step in the dominance of the US Dollar. By 1971 all major powers had abandoned the gold standard, leaving the USD as a global source of stability and value. Consider the following chart that illustrates USD reserve domination.

Are There Any Credible Alternatives to the US Dollar?

Now ends the history lesson portion as we transit into the meat of this piece. The short answer to the question above is, NO. The why behind the no is a little dense but I like to summarize it this way: you can’t build a Dollar out of BRICs.

You may be asking, what is BRIC? BRIC is an acronym for Brazil, Russia, India and China. In 2006, these important developing countries came together to challenge the political and economic power of the wealthier nations of North America and Western Europe. Several other smaller nations have since joined as members.

There is a long-standing economic disaster fantasy that envisions the US Dollar being dethroned from its reserve status by a “basket” of these countries’ currencies in what is referred to as de-dollarization.

Why is the BRIC fantasy a non-starter? Primary among the reasons is a lack of needed liquidity in their indigenous markets. Also important is the currencies’ instability at home and a general lack of trust and/or confidence on the global political and economic stage.

What follows is a quote from a report from VanEck Global Advisors. It does an excellent job illustrating why a shift away from the USD is unlikely and would have minimal impact.

[QUOTE] “To put some meat on this; the Bank for International Settlements’s latest triennial FX survey indicates that the US dollar’s share of all currency turnover has actually climbed from 85 per cent in 2010 to 88 per cent last year. In global finance it is similarly dominant.

The network effects of the dollar cannot be underestimated. The use of the US dollar in international trade and finance has become a self-reinforcing cycle. As more countries and businesses use the dollar for their transactions, it becomes more convenient and efficient to continue to do so, further reinforcing the dollar’s dominance as the world’s reserve currency.

According to The Economist, ‘the doubters’ excitement has become detached from reality. The greenback exerts an almighty gravitational pull on the world economy that has not materially weakened—even if America has recently found that there are real obstacles to exploiting its currency’s pre-eminence.’

The best illustration of the US dollar’s unique status is the global market for oil trading. Most of the trade is denominated in US dollars, even when the parties trading and the barrels of crude have nothing to do with the US. The political will to ease major markets such as commodities off the dollar is apparent; Brazil’s president Luiz Inacio Lula da Silva has called for emerging countries to develop a new currency and move away from the dollar, while Saudi Arabia has said it is in negotiations to conduct a portion of its oil trade with China in renminbi. But the practicalities of trading commodities in non-dollar denominated currencies are difficult.

‘Challengers would need to overcome the dollar’s dominance in oil benchmarks and financial futures. The only credible alternative is the renmimbi benchmark traded on the Shanghai International Energy Exchange,’ said the Financial Times.

Moreover, the Shanghai Futures Exchange’s (SHFE) market share would only rise to 7% from 5% if the Saudis chose to price all their Chinese oil export in renminbi, according to analysts from Norwegian Bank DNB.” [END QUOTE]

The influence of the USD has grown over the past 14 years. For better or worse, the USD is here to stay.

Why Doesn’t the Massive US Debt Matter?

The US is carrying an incredible amount of debt which is suboptimal for many reasons. But why hasn’t this massive debt load imperiled the reserve status of the USD? Two main reasons: foreign ownership of US debt and the role the USD plays in international trade and transactions.

US debt is purchased by the same foreign entities which would theoretically seek to replace the USD. The ongoing purchase of US debt shows a continuing belief in the US as a safe harbor.

Dollar dominance in international trade and transactions remains significant.

According to a Federal Reserve estimate from 1999 to 2019, the dollar accounted for 96% of international trade and transactions in the Americas, 74% in Asia, and 79% across the remainder of global economies, all while the US debt soared.

Until and unless foreign entities halt US debt purchases, the dollar’s reserve status is unlikely to be undone by a massive debt load.

Final Thought

Be aware that there is an entire industry centered on financial doom and gloom and de-dollarization is one of its favorite topics. Nothing lasts forever, but it is hard to see a scenario wherein the USD is deposed as the global reserve currency.

Thanks for reading,

 

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