US's attempt to counter domestic inflation by coming out of the zero rate era led to severe distortions in the global currency markets due to the dollar strengthening.
The tremendous hold of the US dollar—which along with the Euro, is 80 percent of the world's reserve currency assets—has become increasingly problematic for economies worldwide. This was already an issue after the 2008 financial crisis and the subsequent zero percent rate era, leading to distortions of asset prices. The post-pandemic era has aggravated the issue.
First, the weaponisation of the dollar by the US, especially seizing Russian reserve dollar assets, reminded the world of the reach and dependence on the dollar.
Moreover, the US's attempt to counter domestic inflation by coming out of the zero rate era led to severe distortions in the global currency markets due to the dollar strengthening. With the world's safest asset now yielding positive returns, global capital flowed to the dollar—it climbed ~15% percent against global currencies and ~30 percent against the Japanese Yen by late 2022. Central banks around the world could either increase rates with the US Fed (for example, RBI in India), sacrificing growth and yet get some currency depreciation; or hold rates but see their currency tumble (for example, Bank of Japan's stance and the Yen's great fall).
With commodities priced in dollars (for example, oil), their prices fell in dollar terms but not necessarily in terms of other currencies due to their exchange rate depreciation. Effectively, the US distributed some of its price rise to other countries via exporting inflation.
De-dollarisation or dollar+X, and Petro-Yuan
The solution to the compounding problems of Dollar dominance is not de-dollarisation in a conventional way, i.e. replacing the dollar entirely as a reserve asset. A more viable solution instead is dollar+X, i.e., diversification. Similar to how the solution of supply chain overdependence on China is China+X in manufacturing.
For this, the Chinese Yuan becomes an obvious candidate. China is the second-largest economy, the largest by PPP. China, of course, realises this and would love to see the yuan gain global acceptance as a reserve currency. Then maybe it can also print yuan and buy things from the world.
The first step towards becoming a world reserve currency is pricing and trading global commodities in that currency. Currently, crude oil—the largest traded commodity in the world—is priced and sold in dollars, therefore Petro-dollar. Diversifying away from the dollar as a reserve currency would first require globally traded commodities like oil to be traded in additional currencies. This is where China's attempts to create Petro-yuan come into play.
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Having established bilateral currency trades with Russia due to US sanctions, more recently China agreed with Saudi Arabia to trade oil in yuan. Additionally, China was mediating the peace deal between Saudi Arabia and Iran—another oil-producing country. These are significant strides towards creating the Petro-yuan as an additional currency, alongside the dollar, for trading or purchasing oil.
However, diversifying to yuan alone cannot solve the problem entirely. While trust has been lost in the US due to its weaponisation of the dollar, China does not generate much trust either. China's geopolitical issues with several countries also make it difficult to gain acceptance. For example, India refused to settle trade with Russia in yuan and chose Dirham.
To achieve real diversification away from the dollar, the need would be to diversify reserve assets into at least 5 or 6 major global currencies. For that, we may need Petro-Multicurrencies, which become complex and messy.
How about a BRICS CBDC and Petro-BRICS?
Or, a simpler and straightforward approach could be to use a currency indexed to the weighted average of a basket of currencies. This provides a much more manageable and neat trade settlement mechanism and a diversified reserve asset base to hold onto.
The idea of a global weighted average currency is not new. English economist and philosopher John Maynard Keynes first suggested such a currency called Bancor in the 1940s. Keynes elaborated that the value of such a currency could be fixed to a basket of commodities, such as gold, wheat, and cotton, which would stabilise its value and prevent currency fluctuations.
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As international groups go, BRICS is most suited for an alternative trade or reserve currency system. It’s a purely economic grouping of the “next large economies” dominated by the Global East and Global South—a perfect diversification anecdote to the Global West’s Petro-dollar system. Being purely economic grouping also helps nations with disparate geopolitical goals to come together. Having commodity producers and consumers, fiscal deficit, and fiscal surplus nations in the group also augurs very well for creating a sustained trade group.
Interestingly, the modern prevalence and acceptance of digital currencies have made the execution of such global virtual digital currency possible. A wholesale Central Banking Digital Currency (CBDC) for global trade and settlement is within reach now—a possible BRICS CBDC as a new currency of global trade and settlement, backed by the reserves and assets of constituent countries such as Russia, India, China, and others.
The first step in attaining this is to create Petro-BRICS, i.e., oil trade also starts happening in BRICS CBDC along with the dollar. Lately, there has been fair activity on that front too. Several oil-producing countries, including Iran and Saudi Arabia, have expressed interest in joining BRICS. In the recent G20 meeting, Russian Foreign Minister Sergey Lavrov emphasised expanding alternate payments in national currencies within BRICS, SCO, and EAEU. He mentioned at least 12 applications are pending for joining BRICS. More interestingly, there has been a spate of CBDC trials across countries in the last few months—from India to Singapore, Indonesia, Turkey, Iran, and so on.
Despite all these undercurrents and workings, the global currency system remains primarily a geopolitical issue. So whether it will be Petro-yuan or Petro-BRICS remains to be seen. However, one thing is for sure, the Dollar+X currency reserve system is fast becoming a reality. And if push comes to shove, even the US might prefer Petro-BRICS over Petro-yuan as the second global currency along with the dollar or euro system.
Dr Vidhu Shekhar is the Associate Head of Centre for Financial Innovation and SPJIMR faculty in the Area of Finance, specializing in Fintech and Financial Economics. He is a PhD from IIM Calcutta, MBA from IIM Calcutta, and B. Tech(H) from IIT Kharagpur. Views are personal.
[This article has been reproduced with permission from SP Jain Institute of Management & Research, Mumbai. Views expressed by authors are personal.]