Future Prospects for the Global Reserve Dollar, Part 3: A Gold-Backed BRICS Currency

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8 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff examines the complexities of the much talked-about proposition for a gold-backed BRICS reserve currency.

With bad news rolling in for the dollar as of late, predictions of global reserve dollar collapse have been all over the Internet and even in the conservative media.

One of the most-trumpeted challengers eyed to dethrone the dollar’s eighty years of global dominance is the recently proposed but not yet real “BRICS currency” which is in early-stage discussions between Brazil, Russia, India, China, and South Africa.

Adding fireworks to the BRICS story are reports that its member countries are considering gold-backing for the reserve currency, thereby making it an upstart capable of threatening the US dollar’s reserve status practically overnight.

How would such a reserve currency work?

BRICS countries would all trade with another, and they also hope with non-BRICS countries, using a new reserve currency which we’ll call the “bric” or “brics” for plural—not to be confused with the all-capitalized “BRICS” meaning the five countries themselves.

BRICS domestic economies would still operate on local yuan, rubles, rupees, etc… but brics would be convertible into those domestic currencies at a floating exchange rate.

Even if brics turn out accepted only by BRICS countries for use only between BRICS countries, the belief is the sheer volume of BRICS-only trade might still pose a serious challenge to the dollar’s share of international payments and central bank reserve holdings. After all, the BRICS countries themselves represent 31.5% of world GDP which is larger than the G7’s 30%.

And since the bric would in theory be gold-backed—ie. convertible into a fixed unit weight of gold on demand—the supply of brics would grow slowly thereby instilling confidence that its value can’t be easily inflated away.

So given everything in concept going for the bric what are its prospects for replacing or dethroning the dollar?

EASIER SAID...

If the bric took precisely the form just described here, the Economics Correspondent believes it could be the most formidable challenge to the dollar since 1944 and that it would stand a good chance, over time, of eroding real share from the dollar’s acceptance in global trade.

But that’s a big if. 

Because the Economics Correspondent sees the prospects of the bric really coming together as perfectly as promised being pretty slim. The reasons are many, but before we get into a list, first some historical background.

The idea of a supranational alternative to the reserve dollar, traded among nations but not used domestically for purchase or investment, is nothing new.

Special Drawing Rights (SDR’s), based on a basket of currencies, have been around since 1969. In over half a century the SDR’s global share of reserve holdings stands at about 2% compared to 60% for the dollar, due largely to the fact that central banks with large SDR holdings can’t buy or invest in anything with SDR’s—only with domestic currencies.

As UC Berkeley professor and international monetary systems scholar Barry Eichengreen writes, “a reserve currency isn’t much good if you can’t do anything with it.”

Also during the 1944 Bretton Woods monetary conference, when the dollar was selected to serve as the primary world reserve currency, British economist John Maynard Keynes proposed an alternative supranational gold-backed currency he named “bancor” (literally “bank gold” in French) which would be issued by a multinational committee known as the International Clearing Union or ICU.

The ICU would vote on how much to inflate the bancor and which countries would be forced to forfeit a small percentage of their ICU-held bancor balances every year (surplus countries such as the United States in 1944) and which countries would automatically gain bancors (uncoincidentally, deficit countries like Great Britain in 1944). The United States would be given a vote but naturally the ICU structure was designed for deficit countries to outvote the USA.

The bancor proposal was rejected in favor of the dollar which was redeemable in gold at $35/oz. But US domestic inflation quickly brought the credibility of the dollar’s gold redemption pledge into doubt as early as 1960 and the USA reneged completely in 1971.

In the 21st century countries like China, left-leaning academics, and even the IMF have called for a “new Bretton Woods” and the revival of the supranational bancor concept to replace the dollar.

LOTS OF PROBLEMS

So with that historical context, here are some of the challenges a new gold-backed bric will have gaining worldwide acceptance:

1) There have been many proposals over the years for a gold-backed currency, and none have ever materialized. CO readers may recall widely hailed proposals for a Russo-Chinese gold-backed currency in 2008, leveraging the dollar's vulnerability during the great financial crisis and Federal Reserve’s multiple QE's.

Despite lots of headlines and predictions by goldbugs—and the Correspondent considers himself a goldbug too—of a glorious Russo-Chinese gold-based currency to knock off the dollar, nothing ever happened. Those two countries couldn’t agree on a mutual framework and for good reason.

2) Even going back to pre-1971, when the global reserve dollar was redeemable in gold at $35/oz, no government has enacted an honest gold-standard in nearly a century and the Correspondent doesn't think they're about to start now.

Even the 1944 reserve-dollar was only redeemable in gold for foreign central banks, not private citizens, but it's still referred to somewhat incorrectly as "the gold standard." And within just a few years of Bretton Woods’ ratification the USA began inflating the dollar enough to bring even its limited gold convertibility credibility into question. France famously lost confidence in the dollar and bailed out, redeeming its dollar holdings in 1965.

In 2023, nearly a century removed from any honest gold standard, the Economics Correspondent believes the odds of the BRICS countries proposing one are nearly zero.

3) The bancor framework, which some BRICS countries are citing as a model for a future supranational currency, was lauded as a gold-backed currency too, but it was hardly a genuine gold standard either.

Under Keynes’ plan, countries low on bancors could buy more by selling their gold reserves to the ICU. However the ICU would never buy bancors back with gold, making the bancor effectively irredeemable.

This smoke-and-mirrors misrepresentation of gold-backing, a promise to buy gold at a certain price but never to sell it, is similar to Russia’s “gold ruble” that was announced in the spring of 2022. Less informed observers, many with an innate hostility to the United States, naively hailed it as a genuine gold-standard ruble, but nothing could be further from the truth. Just like Keynes’ bancor, a currency that can only be bought with gold but never redeemed for gold in return is not truly gold-backed.

Just one year later the much-hyped "gold ruble" has come to nothing.

Incidentally Keynes’ plan would also have had the convenient effect of sucking up world gold and hoarding it at the ICU, thereby reducing the quantity of gold available to world governments and making any return to a genuine gold standard impossible. Keynes was a staunch opponent of the gold standard which he called “that barbarous relic,” but the Correspondent is sure his plan’s framework was just a coincidence.

4) The 1944 gold-reserve dollar failed, the victim of Uncle Sam’s unrelenting desire for inflation, despite being administered by a single, democratic government with a better-than-average reputation for trustworthiness.

Any proposed gold-bric pledge will have to be upheld by two dictatorships (China and Russia) and at least two precarious democracies (Brazil and South Africa). The prospect of five countries with a myriad of conflicting interests and squabbles maintaining a more credible gold-backed bric currency than the failed Bretton Woods dollar are very low.

5) Despite all the talk of the BRICS countries representing 30.5% of world GDP, the reality is China is over 70% of combined BRICS output making the BRIC really a Chinese-dominated currency. China’s share of BRICS output is only expected grow in the future.

Not only does this arrangement make the other four countries junior partners in a China-dominated arrangement, but de facto administration of the bric by China would bring back all the same decades-old problems that have prevented the RMB from replacing the dollar.

See the Economics Correspondent’s columns on problems with China’s RMB at:

http://www.cautiouseconomics.com/2019/05/inflation-currencies04.html

6) Which leaves us with probably the biggest problem of all: the same inflation temptations that led to the end of the Bretton Woods gold dollar.

Even though the bric is supposed to be gold-backed (an uncertain prospect in and of itself), the domestic currencies of the BRICS countries will still be fiat, and BRICS countries are not expected to forswear inflation from their own monetary policy anytime soon.

What does this mean for overseas holders of brics who wish to invest their reserves in BRICS countries with the same ease that they invest reserve dollars in the United States?

Under such an arrangement inflated local currencies will depreciate against the gold bric, sometimes rapidly.

Non-BRICS central banks will want to park their bric holdings in BRICS nation securities markets to earn a return, but that means they will have to convert their brics into, say, reals to buy Brazilian bonds.

Years later, when they convert their real-denominated investments back into brics the exchange rate will have moved against them, thanks to Brazilian inflation, and they could suffer a serious bric-denominated loss on their investment.

Even if the BRICS countries create some sort of brics-denomiated sovereign securities to challenge US Treasuries—a herculean feat to construct and maintain in and of itself—unlike dollar-denominated US Treasuries BRICS governments will have to back them with tax payments received in their local currencies and convert them into ever more expensive brics.

BRICS countries might pledge to keep their fiscal deficits and inflation below a certain threshold as part of the initial brics framework, but we’ve seen how well those pledges held up with the eurozone's ballooning deficits in the 2010's and eurozone inflation during just the last two years. And that currency union is comprised of far more liberal democracies than the BRICS not to mention a resolutely anti-inflationary Germany at the helm.

The Correspondent doubts a BRICS anti-inflation pledge will be any more credible.

So BRICS countries will be acutely aware that overseas brics holders are avoiding investing in their countries due to exchange rate movements and, unwilling to slow their own currencies’ inflation, will pressure the brics union to inflate the supply of brics to stabilize their own currencies’ exchange rates.

If the BRICS union succumbs to such temptation, which the Economics Correspondent sees as very likely in the medium-to-longer term, the gold-convertibility promise will quickly break down just as it did with the dollar in 1971.

Again, if this sounds like an implausible scenario just look at how much internal strife and infighting has emerged within the euro project. And the euro is a fiat currency with member states that are all more democratic and more economically advanced than the BRICS nations.

And even if the BRICS union resisted all temptations to inflate, overseas holders of brics would still have major concerns over the standard laundry-list of problems that the dollar avoids such as immaturity and transparency of BRICS securities markets, property rights for holders of brics-denominated assets, consistent trade surpluses, and imposition of capital controls. The BRICS countries might pledge to end capital controls to make the bric more attractive but China and Russia actively impose capital controls today while Brazil and India have a recent history.

So in summary it’s one thing to laud the idea of a “gold-backed BRICS currency” and write headlines about its inevitable displacement of the US dollar, but a lot of things have to fall into place perfectly for the reality to match the hype.

The Economics Correspondent can already find several conflicts of interest and priorities between politically unstable BRICS partners that could not only derail the bric shortly after its launch, but possibly prevent any true, honest “gold backing” before it even gets started.

And if the BRICS squabble among themselves enough to threaten the currency’s legitimacy, senior partner China might simply grab the reins in which case the bric becomes a de facto “international yuan” which will default back to the same trust issues that keep the RMB from becoming a major reserve holding today (see links above for more information).