Progress of the BRICS nations: What does this mean for the USD, international economy, and trade?

The recent news of China brokering a deal to trade with Brazil in their own currencies instead of the U.S. dollar as an intermediary international currency has sparked debates and controversy over the global future of the U.S. dollar. This news is the latest in a series of progress being made by the global power of nations coined as the "BRICS" countries that many people didn't know existed until recently. Who exactly are the BRICS countries, what is their end goal and how do their progress impact the USD, the international economy and trade.

Origin of BRICS and their global representation

The BRICS countries comprise Brazil, Russia, India, China and South Africa. The acronym was originally BRIC and was given to these set of countries by Jim O'Neil in 2001, because they maintained rates of high economic growth of all countries, and he believed that they would dominate the global economy in the future. South Africa was added to the list in 2010.

Progress made by these countries over the last 10 years had let many to believe that they operate with the mindset of being the alternative to the G7 countries' global influence on world economy. The G7 countries are USA, France, UK, Canada, Germany, Italy, Japan with the EU in some capacity. The BRICS countries make up 42% of the global population, represent 32% of the global GDP ($52 trillion) and roughly has $4.5 trillion combined in foreign reserves. As of today, the BRICS are not an officially recognized body or organization, but the countries do have an annual summit and multilateral meetings to discuss joint opportunities that can further their global relations and influence. As of today, 12 nations including Egypt, Saudi Arabia and UAE have expressed interest in joining their alliance.

Current Day

The ongoing tension between the Ukraine and Russia with Ukraine having support from US/NATO and Russia aligning with China, has given members of the BRICS more fuel to pursue economics tactics in favor of each other and where it can hit their main adversaries i.e. USA and the West via the U.S. Dollar. This agenda came into play a few weeks ago when Brazil and China announced plans to trade with each other in their own currencies rather than use the U.S. dollar.

USD/Petrodollar background:

Dating back as early as the 1970s, the USD became the global currency of trade for oil-exporting countries when oil prices were on the rise and a standard currency of trading oil easily was somewhat needed. The US was a main importer of oil and made deals with oil-exporting countries, paying them in USD, which started a chain reaction of having the USD widely available and the standard for other oil-exporting and importing countries to use.

These oil exporting countries and businesses invest their earnings in booming and well regulated U.S. financial markets, companies and indices (DJIA, S&P 500 etc.) which further expand the worldwide use of USD for trade and international business.

Brazil is the biggest economy in Latin America and currently the biggest global trading partner with China, accounting for over $151 billion in bilateral trade in 2021. Majority of this trade was done in USD. However, this new agreement will reduce the cost associated with exchanging yuan for real and vise versa, which then reduces their bilateral demand for US dollars and the interest revenue the U.S. Reserves would have gained from these trades. Brazil is a major economy for oil production, exportation and consumption and being the leading oil nation in South America, this gives the BRICS countries more advantage and power with influencing their relations within the Latin America and the Caribbean via Brazil.

Many Caribbean and Latin America countries have the US at their heels with the rise in BRICS countries' trade and economic involvement across the region. It might get to a point where these nations who have lower bargains power than the U.S. and BRICS are forced to make tough decisions that hurt their relations with either side. One thing for sure is that BRICS, via Brazil, has made a statement to the region with this agreement and other nations are paying attention.

Additionally, China's Yuan has replaced US dollars as the most traded currency in Russia, as expected. A French natural gas company, TotalEnergies, brokered a first ever deal last week with a Chinese company to trade liquified natural gas (LNG) in Yuan instead of the USD as an intermediary. Furthermore, this LNG was bought from the UAE in Yuan also adding to China ongoing progress with making deals in their own currency. The rise in oil prices and countries needing a common currency to trade oil are the initial major reasons why the US dollar became the global currency of trade. China brokering deals with the UAE and Saudi Arabia in their own currency and solving conflicts with both countries is a potential path to weaken the US dollar overtime. This can strengthen their own currencies and indirectly the currency of those nations.

Breakdown of Global Currency Trade and Reserves

The USD is still a major and significant player in global financial and trade systems by a long shot, despite recent headlines and moved made by BRICS. According to a 2019 Bloomberg report, the USD is still the most traded currency in the world at 44%, followed by the Euro at 16%. Prior to recent deals, the Chinese Yuan accounted for just 2% of global currency trade.

Bloomberg Report: 10 Most traded currencies in the world in 2019

Additionally, the USD is still the most held currency as foreign reserves in many countries. As of April 7 according to the IMF, the USD accounts for about 60% of global foreign currency reserves, which is more than all other currencies combines. Foreign reserves in Euros are at 20%. The Chinese Yuan accounts for just 2.7%. This poses a major limitation on Chinese yuan to surpass the dollar in any capacity. It's clear the stronghold the USD currently have on the market, and it would take a very significant global phenomenon, perhaps overtime, to weaken the currency.

The Chinese Yuan is the only BRICS nation's currency listed in these charts. Can these strategies by China impact U.S. dominance in reserves and currencies? It all depends on the target nations with whom China chose to leverage with trade agreements. Brazil, United Arab Emirate and Saudi Arabia are major economies and oil-exporting nations with USD reserves and trades that have strengthened their relationship with China.

Some countries, especially those in continental Africa, have expressed opposition with the policies, view, and regulations imposed by US and Europe over the years. Some countries are currently facing sanctions imposed by the U.S., Canada, and Europe. China's move with Brazil could be a source of motivation for other nations to increase trade relations with China, thus simultaneously increasing their Yuan reserves.

Key Considerations with the Chinese Yuan

For the Chinese Yuan to be a successful alternative, countries will have to increase their Yuan reserves so that businesses who trade with China have access to Yuan as opposed to USD. However, the sudden rearrangement of a nation's foreign reserves makeup is complex and poses a major risk to their local currency, business and financial institutions has we have seen historically. Increasing Chinese reserves means potentially reducing U.S. based assets being held by that country in the form of stocks, bonds, treasuries etc. The Yuan currently makes up 2.7% of the world currency reserves; it's not freely being use by many. It's risky to increase reserves in a currency that is not widely used by locals for international trade and not easily converted. Many smaller economies rely of high USD reserves makeup to maintain economic stability and cannot afford such drastic change. As stated earlier, it would take a major global phenomenon for this to happen, or else it would take decades for the Yuan to be the main competition to USD.

Overall, it's not clear-cut to predict how much this strategy will impact the global dominance of the U.S. dollar, but the BRICS are taking advantage of global tensions to further pushed for an alternative. Key global players are being leveraged via favorable trade agreements; nations are motivated to move away from Western influences; and the Caribbean and Latin American countries are trying understanding how to interpret this movement given their strong relations with both the U.S. and BRICS. The United States is the clear leader in global finance, economy, and trade, and this challenge by the BRICS is the latest move in a long while to change this.