China-Brazil Trade Deal Ditches the Dollar

More bad news for the dollar.

Last week, China and Brazil announced a trade deal in their own currencies, completely bypassing the dollar.

This represents another small shift away from dollar dominance.

Under the new deal, Brazil and China will carry out trade directly exchanging yuan for reais and vice versa instead of first converting to dollars.

In a statement, the Brazilian Trade and Investment Promotion Agency (ApexBrasil) said the agreement would “reduce costs” and ” promote even greater bilateral trade and facilitate investment.”

Brazil ranks as the largest Latin American economy, and China is its biggest trade partner. Trade between China and Brazil amounts to some $150 billion per year. China overtook the US as Brazil’s number-one trading partner in 2009.

China also has dollarless trade agreements with Russia, Pakistan and Saudi Arabia.

This is the latest blow to dollar hegemony. Earlier this year, Saudi Arabia Finance Minister Mohammed Al-Jadaan said the country is open to discussing trade in currencies other than the US dollar. This could mark the beginning of the end of petrodollar exclusivity. And in March, Reuters reported that recent oil deals between India and Russia have been settled in currencies other than dollars.

We are still a long way from the dollar losing its status as the world reserve currency, but its dominance is clearly eroding.

Over the last several years, many countries have made a concerted effort to limit dependence on the US dollar. Confidence in the greenback continues to erode thanks to the profligate borrowing, spending and money creation by the US government. America’s use of the dollar as a foreign policy weapon also makes many countries wary of relying solely on dollars.

Under the current global system, most of the world’s trade involves dollars through the Society for Worldwide Interbank Financial Telecommunication (SWIFT). The system enables financial institutions to send and receive information about financial transactions in a secure, standardized environment. Since the dollar is the world reserve currency, SWIFT facilitates the international dollar system.

SWIFT gives the US a great deal of leverage over other countries. The US has used the system as a stick before. In 2014 and 2015, it blocked several Russian banks from SWIFT as relations between the two countries deteriorated and then locked them out again after the invasion of Ukraine. In 2017, the US threatened to lock China out of the dollar system if it didn’t follow UN sanctions on North Korea.

One way to keep the US from using the dollar as a foreign policy billy club is to minimize dependence on the dollar.

This is a big problem for the US government beyond the foreign policy implications. Uncle Sam depends on the demand for dollars to underpin its profligate borrowing and spending. The only reason the US can get away with massive budget deficits and an ever-growing national debt to the extent that it does is the dollar’s role as the world reserve currency. It creates a built-in global demand for dollars and US Treasuries that absorb the money creation and maintain dollar strength. But what happens if that demand drops? What happens if China and other countries decide they don’t want to hold a currency that is losing value every day?

If the demand for dollars tanks, the greenback’s value will quickly erode away. That means even worse price inflation for Americans. And in the worst-case scenario, it could collapse the dollar completely.

As relations between Russia and the US deteriorated prior to the Ukraine invasion, the Russian central bank aggressively divested itself of US Treasuries, selling off nearly half of its US debt in April 2018 alone. In June 2021, Russia announced plans to completely eliminate dollars and dollar-denominated assets from its sovereign wealth fund.

Russian de-dollarization was never a threat to dollar stability. The Russians didn’t hold a lot of Treasuries. But imagine if China started dumping the greenback.

This trade deal with Brazil is another sign that the world is drifting away from the dollar. Credibility and its status as the reserve currency is the only thing the US dollar has going for it. Take that away and the US dollar isn’t a whole lot better than the Zimbabwe dollar.