It’s cold up here in Wisconsin, so I thought we might cook up some hot alphabet soup. Here’s the tasty recipe: 1 pound of ground beef, 3 cubes of beef bouillon, 3 cups of hot water, some spicy vegetable juice, a pound of frozen mixed vegetables, 6 cups of water, a little salt and pepper, and 8 ounces of uncooked alphabet pasta featuring the letters: BRICS, GCC, BRI, SCO. What do you get? Maybe a high dose of inflation and much higher US interest rates.
Why are these particular letters so important? To start, BRICS is an acronym standing for the countries of Brazil, Russia, India, China and South Africa. Russian President Vladimir Putin has high hopes for the BRICS. This past June at the 14th BRICS summit, he announced that the five countries plan to issue a new global reserve currency. If effective, it would be a reliable alternative for international payments, and it would reduce reliance on the dollar and the euro.
Creating a new reserve currency will be difficult. A reserve currency must be held in sufficient quantities by central banks or other monetary authorities as part of their foreign exchange reserves. It can be used in international transactions, international investments and all aspects of the global economy. The US Dollar has been the world's reserve currency since 1945. It is by far and away the most frequently used currency in international commerce, because it is liquid, freely convertible, and because it has a large and liquid debt market that foreign investors can access. That is not true for many of the BRICS nations.
However, a new reserve currency may not be needed, for there is a growing trend to consummate bilateral trade in local currencies instead of the US dollar. In September 2022, the Shanghai Cooperation Organization (SCO) met in Samarkand, Uzbekistan. At the meeting, Iran joined China, India, Kazakhstan, Kyrgyzstan, Pakistan, Russia, Tajikistan, and Uzbekistan as a member state. Altogether, these permanent SCO members now represent 40 percent of the world’s population and more than 30%of global GDP. One of their key decisions was to increase bilateral trade, and overall trade, in their own currencies.
A little later, Russian President Vladimir Putin, while in Kyrgyzstan, stated this goal succinctly: “The work has accelerated in the transition to national currencies in mutual settlements… The process of creating a common payment infrastructure and integrating national systems for the transmission of financial information has begun.”
Words, Words, Words. Is this all talk and no action? No way!
A little over a week ago, Chinese President Xi Jinping landed in Saudi Arabia, and during his visit, Chinese and Saudi Arabian companies signed over $30 billion in trade deals, covering green energy, informational technology, infrastructure and medical industries. Many of the deals were connected to China’s ambitious Belt and Road Initiative (BRI) projects.
In addition, when he met with the leaders of the Gulf Cooperation Council (GCC), Xi promised that Beijing would import crude oil and natural gas in a consistent manner and in large quantities. It is important note that Xi declared that from now on, China will use the yuan for oil trade, through the Shanghai Petroleum and National Gas Exchange. This is a big deal! China has been the largest importer of crude on the planet for five years now – half of it coming from the Arabian peninsula, and more than a quarter coming from Saudi Arabia. Up until now, nearly 80 percent of trade in the global oil market has been priced in US dollars.
Why is all this so important? When nations start using other currencies for international trade and investments instead of the US dollar, the demand for dollars decline. Basic Economics 101 tells you that when you combine this decline with a huge increase in supply in the form of higher US budget deficits, you will get a decline in the value of the US dollar. That will lead to higher inflation.
It also means that China and other countries not using the US dollar, and countries like Saudi Arabia not receiving US dollars, will not have those same US dollars to purchase our mushrooming debt. That will put the Federal Reserve and the US Treasury in quite a bind, and we think they will ultimately have to raise rates to attract new buyers.
All this won’t happen right away, but this train has left the station. It is moving slowly, but it should steadily increase in speed. When Russia and China do reach their goal of an alternative global reserve currency, it will be a train wreck for our highly indebted economy.
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