Andrés Velasco | The futile search for a dollar rival

As photo opportunities go, the one offered by the BRICS summit in Kazan, Russia, was not particularly inspiring: five autocrats and three democratically elected leaders lending their support to a dictator who cannot leave his country because of an International Criminal Court arrest warrant for war crimes.

When launched in 2006, the BRICS – Brazil, Russia, India, and China, with South Africa joining in 2010 – had a fair claim to representing the world’s emerging economic powers. Last year, the group could have cemented its status by inviting large, democratic, albeit imperfectly, emerging economies like Mexico, Nigeria, and Indonesia. Instead, its ballyhooed expansion included four autocracies – Egypt, Ethiopia, Iran, and the United Arab Emirates – three of which do not play in the top league of the world economy.

The BRICS’ main purpose nowadays is to portray Russia and China as leaders of the so-called (and misnamed) Global South. In keeping with that goal, the Kazan meeting had a suitably anti-G7 emphasis: to dethrone the mighty US dollar and replace it in global trade and finance with a currency issued by the BRICS. The initiative’s main backer is Brazilian President Luiz Inácio Lula da Silva, whose doctors kept him from attending the summit in person – he is 79 and recently fell at home.

In January 2023, Lula announced that his country and Argentina would launch a common currency, which eventually would encompass Paraguay and Uruguay, to become the currency of the Mercosur trading bloc. That has not happened, and neither will a dethroning of the dollar by a BRICS currency – at least not the way Lula envisions.

Any introductory economics textbook will tell you that a currency must play three roles. First, it must serve as a unit of account: the price of a loaf of bread is denominated in US dollars, Colombian pesos, or Kenyan shillings. Hence, at previous BRICS summits, members have discussed creating a shared unit of account tentatively known as the R5, since the currencies of all five original BRICS members begin with the letter ‘r’.

The feasibility of this proposal would depend on how stable the R5 turned out to be. The lion’s share of world trade is denominated in US dollars not because of some conspiracy led by the United States, but simply because low US inflation makes the dollar price of most goods reasonably predictable.

A currency must also serve as a medium of exchange. A mechanic who wants to eat a hamburger first gets paid in the local currency and then uses it to buy a meal at a local restaurant. The global equivalent is that a resident of Delhi who wants coffee from Brazil first uses Indian rupees to purchase US dollars to pay the Brazilian exporter, who then exchanges the dollars for Brazilian reais with which to remunerate his workers.

“Every night I ask myself why all countries have to base their trade on the dollar,” Lula said in a speech at the New Development Bank in Shanghai last year. In fact, the answer is simple. To pay for their family expenses, Brazilian sugar workers need reais, which can be easily and cheaply purchased with US dollars, but not with Indian rupees, South African rand, or Ethiopian birr.

The Kazan summit’s communiqué does call for greater use of BRICS members’ currencies, instead of the dollar, in trade among themselves. But this would work only if trade between any two countries were always balanced. For example, if Brazilian consumers wanted to purchase rice from India of a value equal to the coffee Indians wished to buy from Brazil, each trading period would end with no party left holding the other’s currency. But if the value of India’s exports to Brazil were systematically smaller than that of Brazil’s exports to India, Brazilian companies would accumulate large rupee balances – clearly a non-starter.

Post-Kazan discussions have stressed how things would change if BRICS countries issued digital currencies – something that China has started rolling out over the past decade. With today’s currencies, all the international transactions into and out of dollars go through commercial banks, whereas digital currency transactions would do away with private intermediaries and involve only central banks. But the problem of trade imbalances would not go away. Would Brazil’s central bank be comfortable holding sizeable balances of digital rupees, digital Iranian rials, or even digital renminbi? Surely not.

The same conundrum would arise if a BRICS currency (paper or digital) replaced local currencies for intra-BRICS trade. In fact, the problem stems from the third textbook use of a currency: as a store of value. When it comes to savings, we use only currencies that we trust will not be frozen, confiscated, or eroded in value through inflation. To see this principle in practice, just look at central banks’ reserves. Around 60 per cent of global foreign exchange reserves are held in dollars, down from 72 per cent in 2000. Over the same period, the renminbi grew from zero to just 2.6 per cent.

The renminbi’s glacially slow uptake partly reflects the many capital controls China maintains. But more fundamentally, it is because the value of the dollar is underpinned by America’s governing institutions – including its judicial system – which remain far more credible than China’s.

None of this means that the dollar’s role as the global reserve currency is guaranteed forever. As Britain discovered a century ago, things can change if a country’s share of the world economy shrinks too much. And since a country’s currency is only as good as its institutions, Trumpian antics and dysfunction in Washington do not help. Nor did the freezing of Russian assets held abroad and the exclusion of Russian banks from Western payments systems – however justified those sanctions may have been from a political and ethical standpoint.

Since Russia’s invasion of Ukraine, the central banks of China, India, Iran, Turkey, and other countries have been diversifying their reserves to put at least some of their holdings beyond America’s reach. Did they choose to buy more of each other’s currencies, as suggested by the rhetoric of the BRICS summit? Far from it. Instead, they bought gold, driving its price to record heights. That harsh reality may condemn Lula to even more sleepless nights.

Andrés Velasco, a former finance minister of Chile, is Dean of the School of Public Policy at the London School of Economics and Political Science.

© Project Syndicate 2024

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