If Brazil, Russia, and China abandon the dollar, what will take its place?

Would a gold-backed BRICS currency be possible?

To start, we must first understand the role of a “global reserve currency” and why the U.S. dollar holds this position.

Why other countries trade in U.S. dollars

Most countries have their own sovereign currency. So why do foreign nations use the U.S. dollar for international trade? Why do central banks around the world hold so many dollars in reserve?

We live in a globalized economy where businesses, individuals, and governments routinely buy goods and services from foreign nations. If my company only uses Japanese Yen and your company only uses Swiss Francs, it is very difficult for us to trade with each other. To facilitate international trade, we need to agree upon a universal medium of exchange.

Since the end of WWII, the U.S. dollar has been the go-to choice. Here is a quick history of how the dollar ascended to the position of global reserve currency:

How the dollar became the global reserve currency

World War I decimated the major European powers. The U.S. filled the power vacuum and supplanted Great Britain as the leading creditor nation.

Before the U.S. entered WWII, it was a major supplier of weapons and other goods for allied countries. These countries typically paid the United States in gold. By the end of the war, the U.S. owned a massive share of the world’s gold reserves.

After WWII, the Bretton Woods agreement pegged major global currencies to the U.S. dollar, while the dollar remained pegged to gold at a fixed rate of $35 per ounce. This effectively made the U.S. dollar the world’s reserve currency.

Even after Nixon abandoned the gold standard in the early 1970s, the U.S. government maintained the dollar’s reserve status through clever political maneuvering.

We go in depth on Bretton Woods and the petrodollar in The History of The Gold Standard in America.

Companies, banks, and governments around the world continue to use the dollar as their primary reserve currency because it is considered very stable and liquid. It helps that the U.S. economy is the largest in the world.

How international trade works

The following example explains how and why foreign economic participants rely on U.S. dollars for international trade:

1. A Japanese company wants to buy 1,000 barrels of oil from Saudi Aramco (the state-owned oil company in Saudi Arabia).
2. Instead of conducting the transaction in their local currencies – Japanese yen (JPY) or Saudi riyal (SAR) – the counterparties agree to conduct the transaction in U.S. dollars. Aramco has little use for Japanese yen. Aramco wants to receive U.S. dollars because the currency is more liquid, stable, and widely accepted.
3. The Japanese company goes to its local bank and says it needs U.S. dollars to pay for the oil.
4. The Japanese bank then exchanges yen for U.S. dollars on the foreign exchange (Forex) market. The bank charges the Japanese company the current exchange rate to convert yen into USD.
5. Once the Japanese company has acquired U.S. dollars, it sends the agreed payment to the oil supplier.
6. Aramco deposits the dollars in its U.S. dollar account. Accumulating dollars allows Saudi Arabia to invest in U.S. assets, such as Treasury bonds.

Exchange rates between foreign currencies and the USD constantly fluctuate based on these kinds of transactions. If demand for U.S. dollars drops, the value of the dollar will drop relative to other currencies.

For example, imagine the Japanese company suddenly stops buying oil from Saudi Arabia. This will reduce demand for U.S. dollars, because the company will stop acquiring U.S. dollars for international trade. As a result, the strength of the U.S. dollar will fall.

The role of central banks

If commercial banks need more U.S. dollars to meet trade or customer demands, they may borrow the dollars from their central bank (such as the Bank of Japan). Nearly every central bank on earth holds large U.S. dollar reserves.

Central banks have a mandate to stabilize the exchange rate of their local currency. To do this, they must hold large U.S. dollar reserves. For example, if the yen weakens too much, the Bank of Japan might sell U.S. dollars from its reserves and buy yen to boost the yen’s value. These transactions occur in the Forex market.

This helps ensure that companies like the Japanese oil buyer face predictable and stable exchange rates.

Dollar-denominated assets

Commercial and central banks prefer to hold assets rather than cash because cash does not earn a return. When banks acquire U.S. dollars, they typically turn around and purchase U.S. Treasuries and other dollar-denominated assets.

Treasuries are considered one of the safest investments globally because the U.S. government has a long history of repaying its debts. They are also very liquid, meaning they can be easily bought or sold in global financial markets. This liquidity allows banks to quickly convert Treasuries back into cash if needed, while earning interest in the meantime.

Exorbitant privilege

This system gives the U.S. what some economists call an “exorbitant privilege” — the ability to borrow at cheaper rates than most other countries. Since global demand for dollars and U.S. Treasuries is so high, the U.S. government can spend and borrow to its heart’s content without driving up its borrowing costs.

This allows the U.S. to run large trade deficits without the immediate consequences other countries face. Other countries need to worry about accumulating too much foreign debt. When they borrow U.S. dollars (for example), they also have to pay back the debt in U.S. dollars. If their local currency depreciates against the dollar, this debt financing gets very expensive.

The United States can simply issue more debt in its own currency. Because the world uses the dollar as a reserve currency, there will almost always be buyers for U.S. debt.

Ironically, this is one of the primary reasons nations are trying to diversify away from the dollar. Cheap borrowing costs have allowed the United States to recklessly spend and stack up over $35 trillion of debt.

The rise of de-dollarization

The term “de-dollarization” refers to the process of reducing reliance on the U.S. dollar in international trade. There are growing concerns among some countries that the dollar’s dominance gives the U.S. too much economic power.

Reliance on the U.S. dollar exposes foreign nations to economic risks, including:

• Economic sanctions: After Russia’s invasion of Ukraine in 2022, the U.S. and its allies imposed export controls, froze approximately half of Russia’s foreign currency reserves (about $300 billion), and banned key Russian banks from the international payment system called SWIFT. U.S. rivals got the message – if they violate U.S. rules, they will be completely cut off from global trade.
• Monetary policy: Foreign countries are vulnerable to U.S. monetary policy. For example, emerging markets often borrow U.S. dollars, which means they also must pay back the debt in dollars. If the Federal Reserve raises interest rates, causing the dollar to appreciate against their local currency, it becomes very expensive to acquire the dollars to pay back their debt.

Many U.S. rivals want a piece of the “exorbitant privilege” that the U.S. has enjoyed for so many decades. The coalition leading the charge against the dollar is known as BRICS.

What is BRICS?

BRICS is an economic alliance consisting of five major emerging economies: Brazil, Russia, India, China, and South Africa. These nations have formed a coalition to enhance their collective influence in global finance and economics.

Combined, the BRICS countries represent over 40% of the world’s population and contribute approximately 35% of global GDP. Their goal is to build an alternative to the Western-dominated financial institutions like the International Monetary Fund (IMF) and the World Bank.

Key issues discussed at the 16th BRICS Summit, held in Kazan, Russia, in October 2024, include:

• Facilitating trade across Asia, Africa, and Europe by developing roads, railways, ports, and energy pipelines.
• Reducing Western dominance in global finance by expanding new trading platforms such as the BRICS Grain Exchange, introducing the BRICS Clear cross-border settlement infrastructure, and promoting trade, credit services, and payments via the BRICS Interbank Cooperation Mechanism (ICM). There are also talks of establishing an independent BRICS currency.
• Supporting conflict resolution efforts in Ukraine and the Middle East by adhering to the UN Charter.

How did BRICS form?

The term BRIC was initially introduced in 2001 as foreign investment strategy in emerging markets proposed by Goldman-Sachs Asset Management.

The four original BRIC countries — Brazil, Russia, India and China — had a formal diplomatic meeting in 2009, and then formed an intergovernmental organization. South Africa was invited by China in 2010.

Now it is a geopolitical bloc that meets at annual summits and forms multilateral policies. The BRICS expanded in 2023 to include Iran, Egypt, Ethiopia and the United Arab Emirates. Both Argentina and Saudi Arabia were also invited to join BRICS, but they declined.

The BRICS bloc is seen as the largest rival to the G7 (group of seven) industrialized democratic nations — which consists of the U.S., Canada, France, Germany, Italy, Japan and the UK.

What is a BRICS currency?

Recently, the BRICS countries have been conducting more trade in currencies other than U.S. dollars. Now, the coalition is hoping to either increase the use of their own local currencies, or perhaps establish a new currency for transactions between their nations. It would work similar to the way the Euro currency works for all of the countries in the European Union.

The reality is, these nations would have an extremely difficult time replacing the U.S. dollar with a BRICS currency. The capital markets of BRICS nations are not large, liquid, transparent, or stable enough to support the scale of global trade. China is known for its secrecy around currency exchange practices and has faced accusations of currency manipulation. Russia’s currency has been whipsawed by war and sanctions.

Could gold offer a solution?

Gold would serve as a neutral alternative that is already universally recognized, does not rely on any single nation’s monetary policies, and provides the required liquidity and stability.

Will a gold-backed BRICS currency replace the U.S. dollar?

While the BRICS countries have major cultural differences and do not always see eye to eye, they share a common goal: challenging the dominance of the United States.

Introducing a gold-backed BRICS currency could provide them with a real opportunity to disrupt the U.S. dollar’s hegemony. Gold offers a solution to trust issues among the BRICS nations. With gold as the foundation, the currency’s value would stand independently, ensuring stability and confidence in trade.

How would a BRICS currency affect gold?

By reducing global reliance on the U.S. dollar, BRICS nations would elevate gold’s importance in international trade and settlements. To support a gold-backed currency, BRICS nations would likely accumulate substantial gold reserves, driving up demand and increasing gold prices.

Central banks around the world already have, on average, a 20% gold allocation. In fact, central banks currently own 18% of the physical gold ever mined.

This move would likely reinforce gold’s status as a secure store of value and a hedge against inflation, potentially encouraging investors worldwide to allocate more capital to gold.

Additionally, such a transition would make it much more difficult for the United States to finance its deficits. Reduced demand for U.S. dollars would force interest rates higher to attract bond buyers, increasing borrowing costs for the U.S. government. Higher interest rates would ripple through the economy, affecting everything from consumer loans to mortgages to corporate financing (and potentially increasing inflationary pressures domestically).

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