The notion of a world where the USD no longer has dominance has been kicked around at length over the last few years. These concerns are not unwarranted when we consider the resounding chorus from global leaders about the unfair advantage the US has over Rest of World (ROW) given the USD is the world's reserve currency.

 

One school of thought was that a BRICS currency could take its place. Heavy weight economists such as Felix Zulaf have held that narrative. Supporting his thesis was:

• Commodity backed. This BRICS currency will be backed by commodities as opposed to being a fiat currency. China has already bought large amounts of gold. This is appealing to investors.
• Weaponized USD. This new BRICS currency will be used by those who are less friendly with the US (which is a growing number). The weaponization of the USD didn't help.
• Commodity transactions. We are already seeing commodities traded in INR and CNH
• Policy mistakes. Bond markets have reacted more to poor fiscal policy (think Liz Truss). Felix argues this will happen more

 

Gavekal shared similar thoughts back in July 2020 but they argued CNH could be the worlds next hard currency. Supporting their view was:

• US/China tension. Tension with the US since Trump took office has forced China to build a renminbi-based international payments system with roots in HK. This is probably part of the reason the mainland took action over Hong Kong's national security law. If renminbi settlements are run by the Hong Kong Monetary Authority and guided by the PBOC, both international investors and the Government would have found middle ground. Since Trump, I would argue tensions have only got worse. The America first narrative has gained momentum.
• Gov Debt. Agencies have worked hard to make 10yr CGB's the payment system’s “risk free” asset. This is essential in any top-tier payment system as it spurs hedging in the local derivatives market
• Futures. Futures markets are already in place that price oil and gold in renminbi. This could easily expand to two-way trading.
• Gold-renminbi exchange standard. Much like the old days of the gold standard, we could see a similar system emerge but this time where gold is offered freely in exchange for renminbi. This makes sense given China is the world's largest gold producer. This would lend credibility to the currency and would see 10yr CGB returns mirror that of gold.

 

I would however argue that the probability of the USD being dethroned as the world reserve currency is highly unlikely for the following reasons:

• Size of trade. Over 80% of global FX transactions and 50%+ of global trades and payments happen in USD. Changing that will never happen overnight if at all
• Exports. EM nations export commodities/manufactured goods in USD. Exports are usually larger than imports. This means the country accumulates USD FX reserves. While some reserves are held in cash, much is converted into High Quality Liquid Assets (HQLA) that guarantee quick turnover into cash either via selling or repo. The US Treasury is the global leader and provides ample supply of these HQLA via UST. If trade shifts to a BRICS currency for example there may not be the same HQLA available.
• Capital controls. Many EM nations have capital controls. Im not sure what controls will look like from a BRICS perspective
• Fragmentation. Much like the EUR, a BRICS currency will be backed by fragmented countries. The US is united. We have seen the headwinds fragmentation creates.
• Balance sheets. The world is drunk on USD-denominated debt, unwinding these holdings will be a challenge. For context, entities sitting outside the US have accumulated $12 trillion of USD-denominated debt.
• Protection. Its very difficult to see investors get behind any EM currency as reserve when the landscape can change on a dime.