(WSJ 3-15-2022) Saudi Arabia is in active talks with Beijing to price some of its oil sales to China in yuan, people familiar with the matter said, a move that would dent the U.S. dollar’s dominance of the global petroleum market and mark another shift by the world’s top crude exporter toward Asia.
Six days later.
(WSJ 3-21-2022) WASHINGTON—The Biden administration has transferred a significant number of Patriot antimissile interceptors to Saudi Arabia within the past month, fulfilling Riyadh’s urgent request for a resupply amid sharp tensions in the relationship, senior U.S. officials said.
The Saudi military had been appealing to the U.S. since late last year for more Patriot interceptors-—missiles used to shoot down airborne weapons—warning that their supply was running dangerously low.
The decision to go ahead with the arms transfer was part of an effort by the Biden administration to rebuild its relationship with Riyadh. Among other things, the U.S. hopes Saudi Arabia will pump more oil to mitigate soaring crude prices, officials said. But providing Patriot interceptors hasn’t resolved all the strains in the relationship.
When I saw the Wall Street Journal article hit last week, I sat back in my chair. I had been anticipating an attack on our currency from the China-Russia alliance. The Biden administration quickly moved to stem the breach in relations with Riyadh by delivering long-requested military support to bolster our special friendship. Maybe too little too late. I am not sure.
Our weakness is our dependence on debt to finance our government’s affairs. We are vulnerable. Let me explain.
The dollar has been the world’s reserve currency since the Bretton Woods Agreement in July 1944, when the dollar was pegged to gold and allied currencies pegged to the dollar. The U.S. was in a position of immense strength after funding the allied effort in World War II and being largely intact from years of wars fought on other shores. America almost lost this privileged status in 1971 when deficits from war and welfare led President Richard Nixon to drop the gold standard.
In the wake of Bretton Woods’ end, a deal between Riyadh (pictured above) and Washington was struck.
The Petrodollar system has been put in place since the 70s when the Bretton Woods agreement failed. And when the U.S. was a net importer of oil. A special friendship was formed between Saudi Arabia and the U.S., where the former would sell its oil in exchange for the dollars earned to be reinvested into the U.S. Treasury market and a few security promises. The dollar has been the world’s reserve currency and the currency basis for all commodities that have to be bought and sold in dollars since the end of World War II.
Countries that buy oil need to buy in dollars via their local currency before they buy the energy commodity. This consistent demand for dollars is one of the reasons why the dollar had retained its reserve status. But if oil’s biggest players decide to use another method of payment, then the system is at risk of breaking down. Wars have been fought to keep this system in place or to dissuade any member from trying to break away.
French Finance Minister Valéry Giscard d’Estaing famously called America’s “exorbitant privilege” – to fund massive public and private borrowing by issuing dollars, the world’s reserve currency via the petrodollar deal.
The dollar has the reserve currency status, only if it can keep it.
Times are changing.
“Many sovereigns, including U.S.-aligned countries, have realized owning massive amounts of dollars lead to an illusion of stability,” said Victor Xing, principal at Kekselias Inc. “In any moment, a political decision could lead to that dollar reserve being frozen or seized. The Saudis could be anticipating this shift, and pricing crude in yuan would increase their trade surplus in yuan and reduce dollar holdings in an organic way.”
The Chinese Yuan reversed earlier declines in trading following a report by Dow Jones that Saudi Arabia is in active talks with Beijing to price some of its oil sales to China in the currency. The talks with China over Yuan-priced oil contracts have been off and on for six years but have accelerated this year as the Saudis have grown increasingly unhappy with decades-old U.S. security commitments to defend the kingdom, Dow Jones reported. The offshore Yuan erased a loss and traded slightly stronger at 6.39 per dollar.
The outbreak of the Ukraine war and the broad sanctions imposed on Russia have raised serious questions about alternatives to U.S. currency-based markets. The Yuan is in tight focus due to China’s abiding relationship with Russia. Saudi Arabia’s relationship with the U.S., meanwhile, has been hammered by various issues ranging from Yemen’s civil war to potential negotiations around Iran’s nuclear program.
I am not a fan of the Russian President. Nor am I blind to his strategic initiatives. I am always reminded of Sun Tzu’s maxim. “If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle.”
Russia has been planning its Ukraine campaign for years. I believe the Russian President possesses the necessary guile and smarts to wreak a little havoc in our world, beyond Ukraine, striking at the foundations of our western hegemony.
As with Sun Tzu’s maxim, I was taught in my little slice of the world to never underestimate my enemy’s capabilities. Being caught by surprise cost lives in my old profession. Consequently, I don’t suffer from groupthink or lament the potential loss of credibility for thinking way outside the box in my planning initiatives.
Moscow found an early partner in Beijing to support its de-dollarization effort as part of their expanding economic cooperation. Chinese Premier Li Keqiang signed 38 agreements on a visit to Moscow in 2014 deepening cooperation on energy and establishing a three-year currency swap deal worth 150 billion yuan (about $24.5 billion). This deal was renewed for another three years in 2017.
Russia and China shifted further away from using the dollar in bilateral trade in 2018 following the US imposition of heavy tariffs on Chinese goods and the onset of the US-China trade war. While Moscow had previously spearheaded the de-dollarization initiative, Beijing quickly modeled Russia’s strategy when it perceived its own risk to punitive US financial measures. This made way for a 2019 agreement to replace the dollar with national currencies in international settlements between them. Such financial coordination helped Russia reduce its reliance on the greenback in trade. While 80% of Russia’s total exports were denominated in US dollars in 2013, only a little over half of its total exports today are settled in dollars. Most of the decrease was absorbed by its trade with China.
“This process of de-dollarisation is taking place not only in our country but in many countries around the world that have started to have concerns about the reliability of the world’s reserve currency,” said Kremlin spokesman Dmitry Peskov.
Russia’s central bank slashed its holdings of U.S. Treasuries in 2018 and cut the dollar share in its gold and forex reserves in 2020 to 21.2% as of Jan. 1, down from 24.5% a year earlier. The central bank reports that data with a six-month lag.
Why did Russia’s President Putin wait on the Ukraine conflict? I believe Putin had a plan.
Following Russia’s attack on Ukraine, Russian banks have been sanctioned out of the SWIFT system. The ban makes it very hard for them to buy and sell dollars in exchange for their commodities like oil and gas. However, if Russia produces about 10 mpbd and China needs about 10 mbpd, dollars are not required. Why would nations like Russia and China succumb to a system that can be turned off at the drop of Washington’s hat?
The Ukraine war has put China on notice. They have been preparing their own version of SWIFT called the CHIPS system. Currently, CHIPS transactions are minimal when compared to the SWIFT.
The U.S. dollar hegemony has been under threat for years. The pieces of that demise are all falling into place slowly. In the past, Saudi Arabia has dealt exclusively in dollars for their oil. Now they consider China and the Yuan. They have been in talks for years. But make no mistake, China is exceptionally crafty at being the world’s largest buyer of all assets. They can choose the right time to make conditional demands in exchange for stability, trade deals, and other relationships. Money talks.
China is working very hard to proffer stability and creditability in its Yuan. But the Red Chinese currency is miles away from being a reserve currency, let alone replacing one. If Saudi Arabia were to agree to accept Yuan for oil, it would mark a significant step away from historical allegiances. The U.S. dollar/SWIFT hegemony would suffer a crisis of confidence.
The fallout from a loss of the dollar’s sparkle extends to other commodities. The past 70 years of dollar-denominated commodity correlations down the tubes in a matter of weeks and months, not years. A move to a basket of select currencies like euro, yen, yuan, and others would serve as a triage alternative for trading oil and commodities.
Let’s be clear, the wheels of change are already in motion. China is coming. The war in Ukraine might have hastened the dollar’s ultimate tussle for supremacy. Only time will tell. In the short run, dollar crossrate charts don’t lie. At this moment, the world believes in the dollar, the United States, and our ultimate survival as an economic powerhouse with a currency worthy of reserve status.
In the opaque world of international relations, Saudi’s leak of a Yuan-for-oil deal might only have been a harsh signal to Washington demanding a little R-E-S-P-E-C-T. Sensing weakness, Riyadh is using the United States’ escalating confrontation with Russia to their advantage. With Russia out of the global energy mix, all roads lead through Riyadh as two tables below of oil and natural gas production rankings suggest.
Until next time. Stay frosty my friends.