China Setting Up Yuan Clearing in Brazil

Reuters reported that the central banks of China and Brazil signed a memorandum of understanding for Yuan clearing in Brazil. The People’s Bank of China said the agreement would be beneficial to cross-border transactions, further promote bilateral trade and facilitate investment. China made several similar agreements in recent months with smaller economies like Pakistan, Kazakhstan, and Laos. The agreement with Brazil is the most extensive. Brazil is the 12th largest economy, and trade between China and Brazil reached $172 billion in 2022. China believes the agreement will boost the Yuan globally and reduce reliance on the U.S. Dollar for international trade and settlement.

Clearing is a component of transaction settlement. The easiest way to understand clearing is by thinking about a check. Suppose you wrote a check at a grocery store fifteen years ago (before today's real-time clearing mechanisms). The store would deposit the check, but the funds would not be available until it "cleared." Clearing is different from settlement. When the check “clears,” the funds have been verified and reserved. Settlement is the next step when the funds transfer between the banks.

 Understanding what is happening with China and Brazil requires understanding how international transactions happen. International settlement is a process like our check example but with more layers. Suppose a U.S. company needs to pay a U.K.-based company. The U.S. company deposits the money into the bank. When the funds clear, the bank would need to contact the U.K. payment to send payment. Once the funds are received, then the funds would be deposited into the company account. The basics sound easy enough, but the logistics are complicated.

Each country has its system of clearing. In the U.S., it is called the Clearing House or CHIPS. In the U.K., it is called BACS; in Australia, it is BPAY. Each country uses different software, different laws, and infrastructure for settlement. Settling international transactions requires an intermediary messaging system between the countries and banking systems. The various systems communicate via the Society for Worldwide Interbank Financial Telecommunication (SWIFT) system. 

SWIFT is not a clearing or settlement system, as some believe. Instead, it is the messaging system between banks. SWIFT is how banks send instructions for payment. Although most SWIFT transactions happen in Dollars, transactions could occur in any currency both parties agree to. 

Countries realized a long time ago that SWIFT could be weaponized. Suppose a country loses access to SWIFT. It would not be able to send or receive payment instructions. In theory, you can isolate a country from large international trade sectors. The international community, led by the U.S., sanctioned Russia by blocking its access to SWIFT after the Ukraine invasion. After the Russian sanctions, many countries recognized the danger of being too heavily weighted in the Dollar and dependent on the SWIFT system for international transactions. However, an alternative messaging system destroys the U.S. ability to sanction, and Russia created one.

There is a smaller Russian alternative to SWIFT called the System for Transfer of Financial Messages (SPFS-the abbreviation of the Russian words). Russia created the SPFS in 2014 after President Obama sanctioned Russia over the Crimea invasion. After the 2022 sanctions, Russia stopped revealing participating financial institutions, and many unknowns exist. However, it is known that China, India, North Korea, Iran, and many countries in the Eurasian Economic Union have made multiple agreements with Russia about the SPFS payments since 2019. Also, as of January 30, 2023, there are at least 52 Iranian banks connected to 106 Russian banks through the SPFS. In September, Reuters reported that the SPFS grew rapidly in 2022 taking the total participants to above 440 verified participants. 

Brazil is the world's 12th largest economy and a member of the BRICS (Brazil, Russia, India, China, and South Africa). The BRICS’ goal is to overthrow the Dollar’s international hegemony. Brazil and China establishing clearing mechanisms outside the Dollar and SWIFT is a significant development toward conquering the current economic order with the Dollar as the primary reserve currency. The logical consequence after the clearing mechanism is the settlement, which China is quickly developing as a CBDC. In November, China partnered with the Bank of International Settlements (BIS) and four nations to test a cross-border CBDC with $22 million worth of actual settlement. 

It doesn’t require an advanced degree in economics or political science to guess where this goes. According to the U.S. Treasury, approximately 65-70% of all Dollars exist outside the U.S. Eventually, the payment systems and infrastructure will fully develop, creating a viable competitor to the Dollar. The Dollar will lose some of its international transaction status and leverage whenever that happens. Nations will not need as many Dollars in their reserves and will trade those excess Dollars for other reserve currencies and gold. The Dollars will repatriate to the U.S. economy, creating excess cash and significant inflationary pressure. Interest rates will rise quickly, creating a disparity between currencies and many problems in diverse places. The Dollar will become even less attractive to low to middle economies, creating more pressure for alternatives. Countries will trade Dollars for more affordable currencies, and the cycle will accelerate. Some gold-producing countries will want to use gold for international transactions. The cycle will repeat and accelerate again. 

Wait, all those things are already happening and accelerating. The world may be farther in the cycle than it is comfortable admitting. Whether we like it or not, a significant portion of the world wants to overthrow the Dollar. It wouldn't take everyone abandoning the Dollar to feel the sting. It only needs to be enough to create uncertainty. Imagine what would happen to the U.S. economy if Amazon collapsed. Amazon represents about 6.5% of the U.S. GDP. The BRICS currently represent about 25% of the global GDP, with several countries applying to join. The BRICS trading entirely outside the Dollar would be a massive freight train of economic destruction across U.S. markets. It may be time to take action to store wealth outside of the Dollar and Dollar denominated assets like stocks. Want some gold in your retirement instead?

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