The Coming Currency Shock on the Global Monetary System

Authored by: James Rickards

The global desire to move away from the dollar currency as a medium of exchange for international trade in goods and services is familiar. Today's difference is that it's gone from a discussion point to a novelty to a looming reality in a remarkably short period.

Dubai and China have recently concluded an arrangement whereby Dubai will accept Chinese yuan in payment for oil exports from Dubai. Dubai can use the yuan to buy semiconductors or manufactured goods from China.

Saudi Arabia and China have been discussing similar oil-for-yuan arrangements, but more is needed to be put in place. These discussions are complicated by Saudi Arabia's long-standing petrodollar deal with the U.S. Still, some progress is widely expected.

China and Brazil have recently reached a broad-based bilateral currency deal where each country accepts the currency of the other in trade. Meanwhile, China and Russia have a growing strategic relationship as the two superpowers jointly confront the United States. In the trading relationship between the two nations, Russia can pay in rubles for Chinese manufactured goods and other exports. In contrast, China pays in yuan for Russian energy, strategic metals, and weapons systems.

Yet all these arrangements may soon be superseded by a new BRICS+ currency, announced in Durban, South Africa, at the annual BRICS Leaders' Summit Conference on Aug. 22–24.

The currency will be pegged to a basket of commodities for member trade. The BRICS+ commodity basket would initially include oil, wheat, copper, and other essential goods traded globally in specified quantities.

In all likelihood, the new BRICS+ currency would not be available in the form of paper notes for use in everyday transactions. It would be a digital currency on a permissioned ledger maintained by a new BRICS+ financial institution with encrypted message traffic to record payments due or owing by participating parties. (This is not a cryptocurrency because it is not decentralized, not maintained on a blockchain, and not open to all parties without approval.)

The latest information from the BRICS working groups is that this basket valuation methodology is encountering the same problems that John Maynard Keynes encountered at the Bretton Woods meetings 1944.

Keynes initially suggested a basket of commodities approach for a world currency he called the bancor. The difficulty is that global commodities included in any basket are not entirely fungible (over 70 grades of crude oil are distinguished by viscosity and sulfur content, among other attributes).

In the end, Keynes saw that a basket of commodities was unnecessary and that a single commodity — gold — would better anchor a currency for convenience and uniformity.

Based on the impracticality of commodity baskets as uniform stores of value, it appears likely that the new BRICS+ currency will be linked to a weight of gold.

This played to the strengths of BRICS members Russia and China, the two largest gold producers in the world and ranked sixth and seventh among the 100 nations with gold reserves.

These and related developments are frequently touted as the "end of the dollar as a reserve currency." Such comments reveal a need to understand how the international monetary and currency systems work.

The critical mistake in almost all such analyses is a failure to distinguish between the respective roles of a payment currency and a reserve currency. Payment currencies are used in trade for goods and services. Nations can trade in whatever payment currency they want — it doesn't have to be dollars.

Reserve currencies (so-called) are different. They're the savings accounts of sovereign nations that have earned them through trade surpluses. These balances are not held in currency form but in securities.

When analysts say the dollar is the leading reserve currency, they mean that countries hold their reserves in securities denominated in a specific currency. For 60% of global reserves, those holdings are U.S. Treasury securities denominated in dollars. The reserves are not actually in dollars; they're in securities.

As a result, you can only be a reserve currency with a large, well-developed sovereign bond market. No country in the world comes close to the U.S. Treasury market in terms of size, variety of maturities, liquidity, settlement, derivatives, and other necessary features.

So the real impediment to another currency as a reserve currency is the absence of a bond market where reserves are invested. That's why it's so challenging to displace Treasuries as reserve assets even if you wanted. Again, no country in the world can come close to the U.S. in that regard.

But here's where it gets exciting and why the dollar could lose its leading reserve status much faster than previously thought.

That's because the BRICS+ currency offers the opportunity to leapfrog the Treasury market and create a deep, liquid bond market that could challenge Treasuries on the world stage almost from thin air.

The key is to create a BRICS+ currency bond market in 20 or more countries at once, relying on retail investors in each country to buy the bonds.

The BRICS+ bonds would be offered through banks, postal offices, and other retail outlets. They would be denominated in BRICS+ currency, but investors could purchase them in local currency at market-based exchange rates.

Since the currency is gold-backed, it would offer an attractive store of value compared with inflation- or default-prone local instruments in countries like Brazil or Argentina. The Chinese, in particular, would find such investments attractive since they are banned mainly from foreign markets and are overinvested in real estate and domestic stocks.

It will take time for such a market to appeal to institutional investors. Still, the sheer volume of retail investment in BRICS+-denominated instruments in India, China, Brazil, Russia, and other countries could simultaneously absorb surpluses generated through world trade in the BRICS+ currency.

In short, creating an instant reserve currency is creating an instant bond market using your citizens as willing buyers.

The U.S. did something similar in 1917. From 1790–1917, the U.S. bond market was for professionals only. There was no retail market. That changed during World War I when Woodrow Wilson authorized Liberty Bonds to help finance the war.

There were bond rallies and Liberty Bond parades in every major city. It became a patriotic duty to buy Liberty Bonds. The effort worked, and it also transformed finance. It was the beginning of a world where everyday Americans began to buy stocks, bonds, and securities as retail investors.

If the BRICS+ use a kind of Liberty Bond patriotic model, they may be able to create international reserve assets denominated in the BRICS+ currency even without developed market support.

After years of development, this entire turn of events — introducing a new gold-backed currency, rapid adoption as a payment currency, and gradual use as a reserve asset currency — will begin on Aug. 22, 2023.

Except for direct participants, the world has ignored chiefly this prospect. The result will be an upheaval of the international monetary system in weeks.

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