Much like the cruel joke Charles de Gaulle reportedly cracked about Brazil – that it’s “the country of the future and always will be” – predictions of an end to the dollar-based international monetary system seem to belong to a future that will never arrive.
Yet that future is coming, faster than all the prior failed forecasts of the end of dollar hegemony would have you think. In contributing to that shift, Brazil may have the last laugh.
The catalyst can be found in central bank digital currencies (CBDCs), a model for digital fiat money that was, ironically, spurred by governments’ reaction to the 2008 invention of the decidedly anti-fiat Bitcoin protocol. Bitcoin fanatics tend to pooh-pooh CBDCs as centralized tools for government manipulation that local populations will recoil from. In dismissing them, they overlook the massive cross-border shifts these new tools will foster at the macro level.
As key export economies such as Brazil embrace CBDC-based direct settlement with their trading partners, it will spur a trend of de-dollarization over the next decade. The ramifications for U.S. capital markets, for the global economy, and for geopolitical power dynamics are profound.
Brazil's central bank is among more than a hundred experimenting with CBDCs. Others that matter for this discussion include the United Arab Emirates, Russia, Singapore and China, which is streets ahead in rolling out its electronic currency, the e-CNY. China, of course, has made no secret of its desire to reduce its dependency on dollars.
Those five economies account for around 25% of global output, but it’s their outsized roles in world trade – as exporters of oil (UAE’s Abu Dhabi), foodstuffs (Brazil), natural gas (Russia) and consumer goods (China) and as a finance and shipping entrepot (Singapore) – that amplifies the international impact of their respective currency strategies.
Things will get really interesting once such countries’ central banks use digital currencies in direct settlement arrangements with each other rather than going through the dollar, which is currently used as an intermediating currency in 90% of all trade finance. There are signs this is moving forward – from Singapore’s DBS Bank recent move allowing direct payments in e-CNY to multilateral institutions such as the Bank of International Settlements, the World Bank and the International Monetary Fund encouraging member countries to collaborate on cross-border CBDC design. So, buckle up.
Cross-border CBDCs are what matter, not retail
People tend to view CBDCs through a retail lens, seeing them as new digital payment units that citizens would use in daily purchases. That somewhat overhyped idea has fueled concerns about state surveillance of people’s spending – to such an extent that opposition to CBDCs is now a campaign position of U.S. presidential candidates, including Republican hopeful Florida Governor Ron DeSantis and Democrat challenger to President Biden Robert F. Kennedy Jr.
While those privacy concerns are valid – see my critique of the European Commission’s CBDC plans last week – they’re a sideshow. The far bigger issue lies in wholesale, cross-border transactions.
I’ve been arguing for some time that protocol-based interoperability for countries to directly exchange digital fiat currencies would have a dramatic impact on the international monetary system.
By cryptographically locking an exchange rate forward-contracts into a decentralized, blockchain-based escrow structure could protect an exporter and an importer from currency volatility over the timeframe of their trade deal without either party having to trust the other, or anyone else, to hold the funds. Voilà, no need for the dollar to sit in the middle.
Under this system, a Brazilian farmer could agree to provide a Chinese hoggery with soymeal feed for its pigs at a real-to-renminbi exchange rate fixed at signing, knowing that a smart contract would automatically deliver those funds upon arrival of the shipment in Shanghai. With the right oracles in place, all this would happen peer-to-peer without either side having to trust the other’s promise to deliver the funds or the goods.
As such, they could eschew the grossly inefficient current system in which a U.S.-regulated correspondent bank typically acts as the trusted third party in the deal, first exchanging the importer’s renminbi into dollars and then converting them into reals for the Brazilian exporter. If such arrangements proliferated, I have argued, it would reduce global trade-related demand for dollars and, by extension, diminish investment in dollar reserve assets such as U.S. government bonds.
Now, after listening to influential economist Zoltan Pozsar on the Odd Lots podcast with Bloomberg’s Joe Weisenthal and Tracy Alloway, I see that it will likely be the collaborating efforts of central banks, rather than direct importer-exporter agreements, that will forge this path toward disintermediated digital settlement.
Pozsar sees CBDC-wielding central banks adopting new roles as clearing agents for their country’s exporting and importing firms and then using CBDCs to settle directly with their foreign counterparts. In this way, they would displace the all-powerful dollar-based correspondent banks of Wall Street, such as J.P. Morgan and Citibank. The upshot is that countries won’t need as many dollars.
Pozsar sees the trend driven by mid-tier trade-heavy economies, those that play an outsize role in the demand and supply of dollars worldwide. Net exporting countries that run trade surpluses will accumulate fewer dollars and so will supply less greenbacks to global foreign exchange markets. And importers that run trade deficits will have less demand for the dollars they previously needed to pay for things.
Depleted dollar demand
It’s all part of Pozsar’s “Bretton Woods III” vision, where the dollar ultimately loses its hegemonic status over the next decade. Importantly, he sees a different outcome from that of the British pound’s loss of reserve status in the early 20th century, when the U.S. dollar simply supplanted it. Instead, he predicts a multi-currency world where no one currency is dominant, a result made possible because of CBDC clearing mechanisms, which negate the need for reserve currency intermediation. Negotiating counterparts will need to agree on which of their two currencies to denominate their trade deal in, but they won’t have to default to the dollar, or some other universal standard, for actual settlement.
So China is not destined, as some have argued, to become the world’s reserve currency leader. Nonetheless, it will likely see its global influence grow as more of its trade contracts are listed in renminbi. The trend is already underway, with Russia, Brazil, Argentia, the United Arab Emirates, Egypt and other countries all agreeing to denominate trade with China in its currency. Even U.S. Treasury Secretary Janet Yellen has said a gradual decline in worldwide dollar reserves is to be expected.
Depending on how fast the trend occurs, it will have major implications for the U.S. The debt racked up by U.S. consumers, companies and government entities is in part sustained by the ongoing demand for dollar assets by foreign entities. The inflows prop up U.S. bonds, which in turn depresses their yields and, by extension, keeps broader U.S. interest rates low. Americans’ mortgages are affordable because of foreign demand for dollars. If that demand drops off, the cost of capital in the U.S. will rise – likely significantly.
Don’t fight the inevitable
How should the U.S. respond?
I see this is an “if you can’t fight them, join them” moment. There’s no getting around Wall Street banks’ gradual loss of intermediary status, which will mean Washington can no longer use those institutions as agents for surveilling the world’s transactions. The U.S. should accept that reality and consider how to leverage the potentially fleeting advantage it still enjoys as the issuer of a currency desired the world over. It should lean into the “soft power” aspects of the dollar’s dominance – the open, rule-of-law values that underpin its value – and give up on the “hard power” elements of gatekeeping and control.
The soft-power approach works because it reinforces the diminished but still widely held impression of the U.S. as an open, advanced economy and it gives the U.S. a chance to lead monetary innovation for the benefit of users around the world.
That path forward is the opposite of China’s “panopticon” centralized digital fiat currency. There’s no compelling reason for the U.S. to develop a retail CBDC. Rather, official digital dollars should be reserved for inter-central bank cross-border settlement while domestic-use digital money should be opened up to private players using decentralized models with crypto technology. That’s where the real innovative edge will be found.
Sadly, as readers of CoinDesk will know, the U.S. government’s current agenda seems very far from that crypto-friendly approach.