Will The BRICS Currency Affect the Petrodollar?

The year was 1974 and three years had passed since the Nixon shock ended the convertibility of USD to gold signalled the end of the Bretton Woods system. In another strategic move, president Richard Nixon answered Saudi Prince Fahd bin Abdul Aziz Al Saud’s call for humanitarian aid by demanding that Saudi Arabia sell their oil only in dollars in a secret deal which would only come to light in 1978.

The petrodollar’s start was controversial, and many have wondered how long this form of economic imperialism would last. Will BRICS be the final nail in the coffin?

We outlined some implications of Europe’s renewed interest in the Global South in a recent article, and are continuing this narrative by looking at possible implications of the new BRICS currency and new alliances among developing nations.

What is the petrodollar?

While the petrodollar is intrinsically linked to the US Dollar, it is not a currency but rather a prerequisite for the valuation and trading of global oil reserves in USD. Following the USA and Saudi Arabia’s secret handshake, the upward trajectory of the US economy was pretty much locked in place.

This became even more clear when the USA introduced certain caveats for ‘recycling’ petrodollars which allowed foreign nations trading in this reserve to provide compensation to the USA via other means – such as footing the bills for their offshore military or humanitarian initiatives or funnelling petrodollars into U.S. treasuries and bonds. It’s an endless loop, of sorts – a system which ensures the continuity and stability of the U.S. economy.

Global finance and politics have provided us with numerous Janus words over the years. These are words or terms also known as contronyms – and as the latter suggests, these words are inherently contradictory. One such word is ‘equity’ whose one definition denotes fairness and equality, while the other is value and ownership. While value and ownership aren’t necessarily antithetical to fairness and equality, the USD as reserve currency has very much polarised the terms. One could argue that there is little fairness in equities driven and dominated by a single entity and currency.

And yet despite complaints and pushbacks from other nations against USD dominance, there is little to be done without a feasible alternative

For instance, while the Petroyuan has existed for several years,, the Yuan, Ruble and Renminbi aren’t favourable for global trade since these currencies are not readily available, harder to move around and not accepted worldwide. No matter their sentiments, most countries have traded in USD because it has made sense to do so. Even countries like Russia and China used the USD for trade until recent years.

The USD – the investor’s friends

The USD as reserve currency (and petrodollar by extension) has afforded the U.S. luxuries not available to any other nation – the ability to mint money almost unreservedly without driving up inflation. With nearly 60% of international reserves held in USD and trade in precious resources like oil restricted to USD for the most part, the dollar has not faced the same risk of devaluation to date. Moreover, the USD as reserve and petrodollar by extension has allowed the U.S. to offset their deficit.

Ben Bernanke, former chair of the Federal Reserve and senior fellow of Economic Studies at the Brookings Institution notes that the sheer volume of U.S. currency held abroad afford the country an ‘interest-free’ loan of sorts.

It’s no surprise that the USD is a favourite for investors – the currency has become almost self-sustaining through the combination of offshore reserves, trade in services and goods restricted to the singular currency, petrodollar recycling which feeds back to the U.S. Treasury market and ensures its liquidity and resultant low inflation and deficit management. Even during a trade deficits the U.S. can benefit from disproportionate imports or exports – when the currency depreciates it allows for more exports which in turn sees an increase in USD exchange rates relative to other currencies.

Where investments are made in other assets or equities chances are high that dollars will be exchanged somewhere along the line, even if the dollar or U.S. Treasuries aren’t the primary investments.

The Federal Reserve notes that the primary function of the U.S. dollar as a store of value around the world is that it can be saved and retrieved in future without a significant loss of purchasing power.

The USD as foreign exchange reserve declined from 71% to 60% between 2000 and 2021, and yet the Fed noted that this is not a significant threat since this 11% was ceded to multiple currencies and not to a single opposing currency. The Fed notes that the USD’s decline as foreign exchange reserve in recent years (from 71% to 60% between 2000 and 2021). What if a single currency came along which could rival this dominance?

Why is BRICS a threat to the petrodollar?

No matter your personal sentiments about BRICS – financial markets don’t care for feelings. Algorithms and models used for predicting trends certainly take socio-political sentiments into account, but morality is not a prerequisite for investment.

Most analysts are of the opinion that the dollar dominance will not be overthrown anytime soon – it is simply too pervasive and has been used for too long to be outdone overnight. But it would be remiss to focus on a short sprint.

Although BRICS had long since yearned to challenge the dollar dominance, these sentiments have been bolstered in recent years – first by US trade wars with China during the Trump administration, and later by sanctions and Russian asset seizure following their invasion of Ukraine. Freezing Russian assets was aimed at destabilising the ruble – with the world’s sixth largest forex reserves, it seemed a nearly flawless plan. And the plan worked initially – between 24 February and 7 March 2022 the RUB had depreciated from 80,31 to 142,78 against the USD.

But the celebrations were premature. Given European reliance on Russian gas, President Vladimir Putin had countered the sanctions by demanding payment for gas in rubles. Nations had no alternative but to honour these wishes given the energy crisis faced – which saw the RUB recover to 79,58 to the USD by 6 April 2022.

The sanctions and seizure of assets not only proved to the BRICS members that an alternative to the USD was necessary, but that a novel mode of transaction was needed given sanctions also scrapped Russia’s ability to use the SWIFT system.

Another unexpected consequence of the aggressive sanctions was a change in the global south’s sentiments towards the global north.

India’s foreign minister summarised these sentiments in the statement, “Europe’s problems are the world’s problems, but the world’s problems aren’t Europe’s problems”. Indicating that many nations were fatigued by what they see as a power hypocrisy.

Francis Ghiles, associate research fellow at the Barcelona Institute for International Affairs notes that the world has lost patience for the U.S. and Europe’s moral posturing which has seen them turn a blind eye to conflicts and humanitarian crises at will. Such was the case when Sadam Hussein invaded Kuwait, during the failed coup in Venezuela, crises faced after the collapse of the Soviet Union, in the funding of ISIS, the persecution of Palestinians, conflict in Sudan, dictatorship in Zimbabwe and the list goes on. 

It’s no surprise then that more than 30 countries have shown an interest in joining BRICS in the past two years. Formal applications have already been issued by Algeria, Saudi Arabia, Egypt, Indonesia, Bahrain, the UAE, Argentina and Iran. Other nations who have expressed an interest in joining include Afghanistan, Bangladesh, Belarus, Kazakhstan, Mexico, Nicaragua, Nigeria, Pakistan, Senegal, Sudan, Syria, Thailand, Tunisia, Turkey, Uruguay, Venezuela and Zimbabwe.

Swap lines are booming

Important to note is that it’s not just BRICS nations who have set up swap lines to bypass the dollar and SWIFT payment system – countries like Germany, France, Australia and the UK who have traditionally been staunch US allies have each established swap lines to allow for trade in other currencies.

As early as 2014, 23 countries who made up 60% of global GDP had started establishing swap lines to trade directly in currencies other than the dollar.

Several countries have also taken shareholding in the New Development Bank even before official applications to join BRICS – including Bangladesh, the UAE, Uruguay and Egypt.

The New Development Bank’s ‘basket currency’ system currently holds the currencies of the five members and is backed by gold and other rare commodities.

It’s not yet clear how the currency and its digital payment system will function in practice, but the wait will be over soon. It’s believed that the BRICS+ structure will be announced during the BRICS summit in August but the BRICS+ Central Bank Digital Currency (CBDC) and FedNow BRICS payment system will precede this – as it is set to launch this month.

OPEC+ nations and BRICS

The nations which make up the Organisation of Petroleum Exporting Countries (OPEC) and their extended alliance include Iran, Iraq, Kuwait, Saudi Arabia, Venezuela, Qatar, Indonesia, Libya, the UAE, Algeria, Nigeria, Ecuador, Gabon, Angola, Equatorial Guinea, the Democratic Republic of the Congo, Azerbaijan, Bahrain, Brunei, Kazakhstan, Malaysia, Mexico, Oman, Russia, South Sudan and Sudan.

Given 10 of these nations have already expressed their interest in joining BRICS of which Russia is already a part, there’s no doubt that the petrodollar will face massive challenges. While China is not an OPEC+ member, it is also a significant player.

While the USA is the highest producer of oil in the world, OPEC+ nations account for around 80% of petrodollar trade – this means that the bulk of the petrodollar trade could essentially be wiped from the global books in an instant. 

When the war is over

Although the conflict in Ukraine seems to have no end in sight, it is bound to end at some point. Europe’s determined succour has already seen a systematic waning – and their renewed interest in alliances with the global south (as covered in an earlier article) is a sign of the times.

As Francis Ghiles notes – the global north seems to underestimate the economic implications of a post-war Ukraine at their peril. The estimated cost for rebuilding the country is currently set at $500 and while most of the world is adamant that Russia should cover the bulk of these costs, that is unlikely to happen. In all likelihood Europe and the US will split a big part of that bill. But they seem to have lost focus of who will be contracted to do the rebuilding in the first place.

The only way to limit expenditure would be to source materials and labour from the cheapest bidders – and it’s highly unlikely that anyone will be able to rival China in this regard. Add the cost of energy and it’s fairly obvious that the only country with the required resources would be Russia. Peripheral services would most probably be delegated to India. It’s a conundrum for the world’s most powerful nations. Doing all the work themselves would not only drive up costs, but they would also struggle to acquire the necessary resources if they seek to snub BRICS.

The outcome is therefore likely to see a rebuilding of Ukraine which bolsters BRICS nations and further impedes the might of the petrodollar and dollar dominance.

Heading into uncharted territory

It’s not clear how the new BRICS alliances and currency will impact global markets, but we are sure to see some interesting developments in coming months.

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