Several largely overlooked items came out of China this week. First, the Shanghai Exchange is moving toward trading in petro-yuan. As we have seen with gold, Shanghai is a very effective delivery based market. This helps set the stage for Saudi Arabia to disengage from its 1973 Petro-dollar agreement, which essentially involves selling oil in U.S. dollars in exchange for U.S. debt. In the last few years the Saudis have been the most aggressive country in the world in terms of adding to Treasury holdings, now holding a stash of $700 billion.
The alternative really doesn't seem so far fetched at this late stage: Simply begin selling oil to Europe and China in currencies other than the U.S. dollar. China is now Saudi Arabia's biggest oil customer. With the start up of the joint Sino-Saudi 400,000 bbd refinery at Yanbu next September, this promises to widen further.
It's important to note that China is already moving to buy all of its oil in yuan. So far, Russia, Iran and the UAE transact in yuan, while others have the option and await an opening. The new exchange will facilitate that. But as Libya's Gadhafi found out, putting forth a challenge (Gadhafi's Gold-money Plan Would Have Devastated Dollar) to the Petrodollar regime will end your life like some scene out of Beatlejuice.
I have to admit that because I believed Saudi-U.S. relations to be symbiotic, I haven't really focused much on the petro-dollar aspect of the Ponzi scheme. I believed that the U.S. going against the interests of both Israel and the Saudis on both Syria and Iran was unlikely. In fact I thought an operation against Iran was likely. But now I think Iran has nukes, maybe a half dozen small weapons, a fait accompli, so there is no need or urgency to make dozens more when your target is a confined area. I had also generally believed that a sudden, overnight collapse of the petro-dollar was a low-odds event. In reality, however, the petro-dollar system is becoming obsolete and can no longer be sustained. As such, the blood (dollars) supporting it will bled out in spurts.
So post-facto Obama has cut a deal with Iran to lift some sanctions, against the wishes of Israel and Saudi Arabia. This will cause a furor and fallout, and possibly speed the bleed out of petro-dollars. If China wants to buy in Yuan are the Saudis going to argue at this stage. That alone would take a big chunk out of the Petrodollar scheme's hide. A simple Google search reveals dozens of stories about this. An example is in the Daily Mail:
Upset at President Barack Obama's policies on Iran and Syria, members of Saudi Arabia's ruling family are threatening a rift with the United States that could take the alliance between Washington and the kingdom to its lowest point in years."
U.S.-Saudi relations are poor because Obama hasn't shown a willingness to engage in military operations like some hired mercenary. That's strange because Obama is a mercenary in every sense of the word. So I'm wracking my brain as to how this could be played out to somehow support the petro-dollar con. Perhaps now Israel and the Saudis will team up and take out Iran's facilities with the U.S. uninvolved and winking from arm's length?
If not, the end of petro-dollars and its recycling would mean an end to the era of cheap imports and super low interest rates for the U.S., and would also reset the global economy. Most major developed countries rely on oil imports, which are purchased using dollars, so they are forced to hold large stockpiles of dollars (estimated at 4-7 trillion) in order to continue importing oil. In turn, it also creates consistent demand for dollars and prevents the dollar from losing its relative international monetary value, regardless of what happens to the U.S. economy.
It could also mean that all the dollars printed up and afloat overseas to support Dollar petro purchases come flooding back into the U.S. and create severe inflation. Even beyond bad U.S.-Saudi relations, all of the incentives are in place for it to happen. With the trajectory of the money supply turning up, that could already be happening given that China-Iran and Russia are not playing petrodollar ball. The three month trend is running hot.
In addition to changes in Saudi Arabia, the petro-dollar is being steadily eroded by the gas pipelines out of the "Silk Road." Gas is not subject to petro-dollars terms and the countries with the product prefer non-U.S. currencies and even gold. This end runs U.S. dollar hegemony, and I will devote a separate post to this topic.
If China wants to buy oil in yuan, then it would be of benefit to buy it with a stronger currency. For China, buying in yuan instead of dollars is about the easiest, most low hanging fruit type of economic benefit on the menu. No doubt, its leadership has recognized that it could be helping the purchasing power of its own people rather than continuing to export goods to the U.S. in exchange for increasingly questionable, vendor-financed Treasury debt. Plus, it has the added perk of knocking the U.S. off of it perch. With ongoing political ineptitude and more fiscal Kabuki theater on the horizon, the timing is perfect for change -- and who would blame the BRICs for resetting the game? Now this little-noticed game-changing policy announcement came out of China this last week and ties everything together. This is logical if you are making a break from the petrodollar system:
'It's no longer in China's favor to accumulate foreign-exchange reserves,' Yi Gang, a deputy governor at the central bank, said in a speech organized by China Economists 50 Forum at Tsinghua University yesterday. The monetary authority will 'basically' end normal intervention in the currency market and broaden the yuan's daily trading range, Governor Zhou Xiaochuan wrote in a guidebook explaining reforms outlined last week following a Communist Party meeting."
The other begged question: If the Chinese are not going to add to foreign currency reserves, then what are they going to use instead? The answer is obvious: Gold. In fact, I would anticipate an acceleration of Chinese gold purchases well above the robust levels seen now. In actuality, this news seems to confirm what has been in play since last spring: No new Treasuries and huge gold purchases. This is not something to be lightly dismissed. I anticipate that as the petro-yuan and yuan in bilateral trade is launched in earnest, the PBoC will quietly announce the figures for it new gold tonnage. It will be much higher than the consensus.