Brazil-China deal: bypassing the United States Dollar and Neoclassical Realism
por Lucas Cavalcanti dos Santos
“We won't have to talk about sanctions in five years because there will be so many countries transacting in currencies other than the Dollar that we won't have the ability to sanction them”.
US Republican Senator Mark Rubio, on Fox News, March 30, 2023.
Introduction
On March 30, 2023, Brazil and China signed a deal to enable mutual trade and investment directly through the local currencies, casting aside the United States dollar as an intermediary. This was one of more than twenty bilateral cooperation agreements signed by the two governments during the Brazil-China Economic Seminar in Beijing, according to the Brazilian Trade and Investment Promotion Agency(Apex-Brasil). In addition, the Brazilian bank BOCOM BBM became the first South American bank to join China Interbank Payment System, the Chinese alternative to Swift payment network, which enables cross border payments. Officially, these deals are aimed at reducing transaction costs and facilitating commercial relations. However, more than merely cutting costs, Brazil and China have underlying geopolitical motivations. Furthermore, this event is part of a broader movement in the international financial system, a gradual shift away from the US dollar explainable by the Neoclassical Realist lens.
US Dollar dominance: Exorbitant Privilege and Extraterritorial Power
The US dollar's dominance originated with the Bretton Woods system in 1944. The USD was backed by gold, and other currencies were backed by USD and had to float along with it, within 1% variation. In the late 1960s, US deficits rose, and in the 1970s, allies started questioning the system's sustainability. The US left Bretton Woods in 1971. But in 1974, Saudi Arabia agreed to price its oil exports in USD in exchange for arms sales. This helped to increase the global demand for US dollars, giving rise to the “Petrodollar system” (SLAWOTSKY, 2020).
Today, the USD serves as a safe and stable storage of value in the form of US Treasury bills, which can be quickly exchanged for cash plus interest payments. This happens because of its high liquidity as it's freely convertible, accepted worldwide, and administered within a rule of law framework. Additionally, it’s also free-floating — i.e., insulated from government interference on exchange rates—, and backed by the richest and most powerful economy in the world. And it’s not only used as reserve currency by sovereign countries, but also as a transaction currency in most international trade.
These facts have important implications, of which two deserve to be highlighted here. First, because foreign institutions and governments value the USD’s convenience so much, they are willing to pay more for US Treasury securities — that is, to accept lower interest rates. In other words, the United States can finance its national debt for much cheaper than the rest of the world, giving it enormous advantages, which Charles de Gaulle has labeled exorbitant privilege (EICHENGREEN, 2011, p. 4).
Second, having control of the global currency gives the United States exceptional and unmatched extraterritorial power. This power is exercised largely through the Office of Foreign Assets Control (OFAC), which maintains the Specially Designated Nationals and Blocked Persons List (SDNs). Listed entities have their assets in US jurisdiction frozen, and American persons are prohibited from doing business with them (US Government, 2023). Due to the fear of losing access to the USD and the American market due to violating US laws, most foreign companies and banks comply with the sanctions by not doing business with SDNs. In clearer words, US domestic laws, policies, and interests are enforced outside the United States territory. Over the years, however, the US has increasingly abused this extraterritorial power to fold foreign companies and governments to American wishes. This behavior earned the US many geopolitical gains, but it also caused backlash.
Abuse of sanctions
In 2020, President Donald Trump unilaterally left the Iran nuclear deal (JCPOA) and reenacted heavy sanctions against Tehran despite criticism from the international community (France24, 2020). From 2014 to 2019, the US imposed at least 43 unilateral coercive sanctions on Venezuela, which effectively removed it from the international financial system and killed its economy, aggravating the humanitarian crisis — even payments for medicine were blocked (The Lancet, 2019). In addition, Trump also imposed sanctions against Chinese tech companies, like Huawei, based on espionage charges without providing proof (CNN, 2020). These measures against China were not only kept but intensified under President Biden (The Guardian, 2022). The list of sanctioned sovereign states also includes Russia, Cuba, Syria, Afghanistan, North Korea, Yemen, among others (US Government, 2023).
But adversaries are not the only targets. In 2020, the US imposed sanctions on senior officials of the International Criminal Court (ICC) in an attempt to stop it from investigating American war crimes in Afghanistan (BBC, 2020). Likewise, US allies have also suffered. In 2009, the US coerced Swiss banks — prestigious for their secrecy and central to the country’s economy — to violate Switzerland’s domestic laws in order to comply with American laws by sharing private information about thousands of clients vaguely suspected of tax evasion (Financial Times, 2009). In 2019, Olaf Scholz — then Finance Minister and now Chancellor — denounced that the United States violated Germany’s sovereignty by sanctioning the Nord Stream 2 gas pipeline, which links Germany to Russia (BBC, 2019), punishing European companies and banks involved with its construction.
In 2019, two Iranian ships loaded with Brazilian grain exports couldn't return to Iran. They were stuck in Paranaguá port because Brazil's Transpetro feared retaliation for selling bunker fuel to the ships (Reuters, 2019). In 2020, Brazilian oil company Petrobras had to publicly state that it wouldn’t hire oil tankers blacklisted by OFAC after visiting Venezuela and also added specific language to shipping contracts to clarify that position (Reuters, 2020). More recently, in February 2023, US Senator Ted Cruz pressured President Joe Biden to sanction Brazil over allowing Iranian war ships to dock in Rio de Janeiro (CNN, 2023).
Moreover, the US sanctions against Russia’s and Belarus’ fertilizer exports due to the Russian-Ukrainian war in 2022 posed a significant threat to Brazil. The Brazilian economy heavily relies on exports of agricultural and livestock products, which require intensive fertilizing. Unlike the US, which has a robust domestic production, Brazil imports 85% of its fertilizer consumption, of which 30% comes from Russia and Belarus (COLUSSI et al., 2022, p. 1-2). Therefore, US sanctions represent a threat to Brazil’s national interests, its economy and, ultimately, the well-being of the Brazilian people.
A security imperative: hedging against the US dollar
Neoclassical realism (NCR) posits that a country’s foreign policy is driven by its position in the international system, especially regarding material capabilities (ROSE, 1998, p. 146). However, it’s more nuanced than traditional realism in that NCR acknowledges that countries respond to the imperatives of the international system through policymakers, which in turn may have different perceptions of the systemic pressures and are also influenced by several other actors, such as institutions, interest groups, and the public opinion.
In other words, foreign policy (dependent variable) is driven by balance of power at the systemic level (independent variable). But translating systemic pressures to policy skews lower-level variables like domestic politics (intervening variables), which affect the policy output. Additionally, Stephen M. Walt (1985, p. 9) writes that States don’t balance or bandwagon only according to perceptions of raw material capabilities, but mainly according to perceptions of threat. He identifies four variables of threat: 1) aggregate power; 2) proximity; 3) offensive capability; and 4) offensive intentions.
China and the United States are the two largest economies in the world, both are relatively far from Brazil yet are its two biggest trading partners, and both have far greater offensive capability compared to the rest of the world. Thus, the first three variables are roughly equivalent, at least for what concerns this analysis.
Walt’s fourth variable, however, can partially explain why Brazil (and other states) have agreed to do business with China without the US dollar. Brazil, like most of the world, holds USD as international reserves, totaling US$321 billion in February 2023 (BCB, 2023). Because the United States has demonstrated not only intentions but also willingness to abuse its extraterritorial power to violate the sovereignty of other countries through illegal unilateral sanctions, we should expect countries to increasingly diversify the currencies utilized as reserves and for transactions around the world.
When the US, based on American interests, constrains a sovereign state’s ability to act in favor of their own necessities, it creates a threat to them. Therefore, mitigating this threat becomes a security imperative. However, as NCR poses, this is a process that can be faster or slower, depending on various factors — such as the policymaker’s perceptions, domestic politics, opportunity, and institutional framework. Evidently, the major obstacle to replacing the US dollar is that there is no viable alternative, i.e., there is no other currency that meets all the traits that make the USD so convenient. On the other hand, to mitigate the threat of unilateral sanctions, the USD doesn’t actually need to be replaced.
USD vs Digital Yuan: a sneak peek into the future of the international financial system
As discussed, the American ability to sanction so effectively derives from the centrality of the USD in the international financial system. This centrality makes it very unpractical to engage in cross-border operations without interacting with US entities. However, Washington’s ability to sanction could still decrease if the US dollar merely loses ground to alternative currencies. If the governments and institutions gain the option to carry out a fraction of their trade and investments through alternative currencies, it could mean that, even as the USD would remain the preferable currency to hold and use, it would no longer be necessary. One such alternative is the digital Yuan.
In this sense, Slawotsky (2020) argues that, despite its many advantages over the Yuan, the USD's dominant position may be challenged by transformative events. He writes that claims about the longevity of the USD's hegemony are unwarranted for three reasons: motivation, backlash, and innovation. First, motivation means that the digital Yuan became an existential priority for China because of the dollar weaponization by the US. Additionally, China’s single party structure could liberalize capital controls faster than expected if incentives increased enough, which would enable faster internationalization of the Yuan. Second, the backlash of Washington’s sanctions abuse could facilitate the acceptance of the digital Yuan abroad.
Finally, innovation refers to China’s lead on the development of Central Bank Digital Currency (CBDC) technology. CBDC refers to a digital currency issued and controlled by a central bank. It differs from regular electronic money available in banking apps and e-wallets because these are issued by commercial financial institutions, whereas a CBDC is issued by the central bank. This means that CBDC is a legal tender and fully backed by the government, thus safer. As long as the risks are managed, CBDC also has a number of advantages that makes it potentially disruptive, such as: allowing a superior volume and speed of transactions than the current USD financial infrastructure; precision transactions; fewer intermediaries; lower costs; interchangeability among currencies; financial inclusion; improved monetary policies and financial stability, and data collection. The latter may raise privacy concerns, but these are remediable depending on how the CBDC is designed (ENGERT; FUNG, 2017).
Therefore, CBDCs could replace regular currencies. China’s lead with the digital Yuan could give it the first mover advantage to set the global standards and best practices. Furthermore, upon domestic acceptance, the digital Yuan could be internationalized through the Belt and Road Initiative before going global (SLAWOTSKY, 2020). Although the Yuan is unlikely to replace the US dollar (YU, 2014), it could lose ground faster than expected because of China’s increasing incentives, innovations, and the backslash against US behavior (SLAWOTSKY, 2020). This scenario may drastically reduce America’s sanction power, which is a desired outcome for those threatened by it.
Conclusion
In this sense, the recent Brazil-China deal to bypass the US dollar in bilateral trade and investment is motivated by more than just facilitating business through cost reductions. Brazil and China have underlying geopolitical incentives. They are balancing against the threat perception caused by the United States’ offensive sanctions abuse. Moreover, it is likely an instance of a larger international shift away from the US dollar, as there are other countries affected — friends and foes. Although the Yuan is unlikely to replace the USD in the short-term, it could happen earlier than previously thought because of China’s increasing incentives, the innovations regarding the digital Yuan, and the backslash against US behavior. Finally, facilitating commercial relations with China can be a double-edged sword. In the case of Brazil, if not managed carefully, it could increase deindustrialization and economic dependence (SVAMPA, 2019).
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