Can BRIC Countries Kill The US Dollar?

Former US President Donald Trump has expressed concern that China could displace the US dollar as the global reserve currency. The warning follows reports of agreements between various nations to use the yuan in commodity transactions.

For years, rumors have circulated about the demise of the US dollar as a global reserve currency, but the greenback continues to be the most traded and extensively used currency in the fiat world.

The US dollar is by far the most traded currency on the foreign exchange market, according to the Bank for International Settlements. In 2022, the US dollar “remained the preeminent vehicle currency in the globe.” In April 2022, it was on one side of 88% of all transactions, unchanged from the previous survey.

Federal Reserve data shows $98 billion of deposits left the banking system in the week after the Silicon Valley Bank collapse. Most of the money went to money-market funds, as the Bloomberg data shows that assets in this class rose by $121 billion in the same period. The data shows the challenges of the banking system in the middle of a confidence crisis.

However, as many analysts point out, this is not necessarily the main factor that dictates the risk of a credit crunch. Deposit flight is certainly an important risk. Many regional banks will have to cut lending to families and businesses as deposits shrink, but in the United States bank loans are less than 19% of corporate credit according to the IMF, while in the euro area it is more than 80%. What will generate a credit crunch is the destruction of capital in the asset base of most lenders.

The slump in mark-to-market valuations of all asset classes from loans to investments is what will ultimately drive an inevitable credit contraction.

Negative interest rates and quantitative easing have wrecked the economic system. Negative interest rates destroy the profitable portion of a bank’s asset base, and no amount of cost-cutting or efficiency initiatives can compensate for this loss. Furthermore, persistent quantitative easing has transformed the investment side of the balance sheet into a ticking bomb.

Deutsche Bank is the latest headline after Credit Suisse. Nonetheless, everyone was aware that Credit Suisse faced enormous obstacles and a lack of profitability. On the other hand, Deutsche Bank was recovering from years of losses. Since 2019, Deutsche Bank has launched a solid rebalancing plan, with a goal of increasing return on tangible assets to 8%, a massive cost-cutting initiative, and a shift from investment banking to its core lending activities. After years of losses, the core capital ratio grew and profits began to emerge, indicating the apparent success of the plan.

Every time there is a banking crisis some scratch their heads and wonder; how could this happen? Surely it must be greed, bad risk management or lack of regulation. More intervention should solve it. However, all those excuses miss the most critical point: The U.S. banking system was destroyed by design, and the big banks played along with it.

The fractional reserve system has always been a problem. Very few people understand how quickly the capital of a bank can dissolve. The entire balance sheet of a bank is a deck of cards and the smallest decline in the profitable asset base -loans- or the volatile liabilities -deposits- would make the entire building collapse because the problem has always been to take additional long-term risk using short-term liquid liabilities -deposits-.

The mismatch between assets and liabilities makes the entire balance sheet collapse and there is never enough capital and reserves to cover the losses. However, decades of prudent banking and increasingly sophisticated risk management tools helped reduce the risk of a bank failure. It was never going to be perfect, but it worked for the most part.