This post is about the U.S. Dollar’s long term direction.
The world’s nations can be categorized into 2 main groups:
- Those who are America’s allies. (E.g. Europe, Canada, Australia, Japan, Saudi Arabia)
- Those who aren’t America’s allies. (E.g. China, Russia, Brazil, Africa, much of the Middle East, and many developing nations).
The story here focuses on the 2nd group – nations who aren’t America’s allies.
China has long wanted to replace the U.S. as the world’s pre-eminent financial force. President Xi Jinping wants “a great rejuvenation of the Chinese people”. In order to do so, China must replace the USD with something else as the world’s reserve currency.
Few countries will accept the Chinese Yuan in international trade. They don’t trust it. And at the moment, there is no other currency that can replace the USD as the world’s reserve currency. The Yen and Euro are even worse than the USD. Japan’s economy has been stuck for the past 2 decades, and nobody knows if the Euro will even be around in 10 years.
Other developing nations
What do many developing nations in Asia, the Middle East, and South America all have in common?
- A lot of these countries are sanctioned by the U.S. In other words, the U.S. tries to use its economic/financial power to impose its political will on these countries. The global financial system is USD-based, and the U.S. government controls the USD. The U.S. government uses the USD as a political weapon. But more importantly….
- Many of these countries are commodity suppliers (e.g. Russia, Brazil, the Middle East). Meanwhile, China is a commodity demander (China imports a lot more commodities than it imports). Prior to 2017, these countries transacted in USD, which is the world’s reserve currency.
- These developing countries got fucked by the 2014-2015 USD bull market. A lot of these countries’ debt is denominated in USD. So when the U.S. dollar soared in 2014-2015 AND the Federal Reserve started to hike rates, servicing these debts became much more expensive.
- Commodity prices (oil, copper, etc) crashed while the USD soared from 2014-2015. These countries rely on commodity exports. Oil prices cannot recover to previous levels because U.S. shale is too powerful. As a result, developing countries and Saudi Arabia are really hurting. Governments in these countries rely on oil revenues. With oil prices so low, these countries are desperate. This is why Saudi Arabia’s crown prince has literally resorted to robbing money from his extended family (“corruption” charges, and the only way to get out of these charges is to sign your assets over to the state).
A unique situation
We have a unique situation here.
- China wants to replace the USD with something else as the world’s reserve currency. Preferably the Yuan.
- Commodity supplier nations need to be paid at above market prices for their commodities and want to avoid the USD. It just so happens that China controls much of the world’s commodity demand.
China knows that over the long run (e.g. 30 years), commodity prices will be much higher than they are today. Since China doesn’t have sufficient resources, it needs to lock in a long term price for their imports.
Commodity supplier nations have an IMMEDIATE NEED for cash. They know that commodity prices will rise in the long term, but will not rise significantly enough over the next few years to solve their financial problems.
In other words, China needs to solve a long term problem while commodity supplying nations need to solve a short term problem.
China is striking one-to-one agreements with these commodity nations. The agreements go like this:
- China will agree to long term fixed contracts to buy these countries’ commodities at slightly above market prices, thereby alleviating pressure on their governments.
- In return, all of these commodities will be paid for in Yuan. This is called the PetroYuan, which will replace the current PetroDollar. However, the Yuan will be immediately convertible into gold.
In other words, China is re-instituting the gold standard as the world’s reserve currency. These countries (e.g. Saudi Arabia, Russia) might not believe in the Yuan and might not want to hold vast reserves of Yuan. But they do believe in gold.
*The Middle East loves gold. Asians love gold. It’s a cultural phenomenon that stretches back thousands of years.
How this will impact the U.S. Dollar
This is a long term bearish factor for the U.S. Dollar. Here’s an example.
Previously: if Germany or China wanted to buy oil from Kuwait, they needed to buy USD before they could pay for the oil. This created a massive artificial demand for USD.
But with the PetroYuan, oil supplying nations have another choice. They can sell their oil for Yuan and then immediately convert it to gold, therey bypassing the U.S. Dollar altogether. This also means that oil suppling nations can bypass the U.S. restrictions, economic, and political sanctions. The PetroYuan neutralizes the USD as a political weapon that’s used by the U.S. government.
Gold has an ancient history of being a reserve history, which is why it’s particularly attractive to oil suppliers that don’t get along with the U.S. (e.g. Russia).
Where is China in the PetroYuan process?
The PetroYuan process is not yet complete, but should complete be by the end of 2018.
The Shanghai International Energy Exchange is launching a crude-oil futures contract that’s denominated in Yuan. This means that oil supplying nations can sell their oil for Yuan and avoid the USD. More importantly, these Shanghai crude-oil futures are linked to physical gold. This means that sellers can exchange their Yuan for physical gold through the Shanghai and Hong Kong exchanges.
This futures contract will be launched by early-2018. China has already convinced several big commodity suppliers to accept Yuan as payment.
- Iran is the world’s 5th largest oil supplier. China has bought the majority of Iran’s oil supply since Iran has been sanctioned by the U.S. for years. Iran has accepted Yuan as payment for oil.
- Venezuela has accepted Yuan as payment for oil.
- Russia has accepted Yuan for crude oil and natural gas (30 year contract).
The biggest whale in the room is Saudi Arabia. Saudi Arabia has yet to accept Yuan for oil, but they are moving in that direction.
Saudi Arabia and the U.S. struct the PetroDollar agreement in 1974.
- All oil sales will be in USD (this benefits the U.S.)
- In exchange, Saudi Arabia receives the U.S.’ military protection, arms, and support in the Middle East (against e.g. Iran).
Saudi Arabia and the U.S. are now drifting apart to the point of no return.
- Through shale production, the U.S. is now a direct competitor to Saudi Arabia. Previouly, the U.S. was Saudi Arabia’s biggest customer.
- Saudi Arabia is turning to Russia for military protection. Recently, a 1500 person delegation from Saudi Arabia visited Russia. This is the first visit by a Saudi king to Russia. This is a huge F.U. to the U.S. Saudi Arabia is now buying weapons from Russia.
- Donald Trump just gave Saudi Arabia the finger by naming Jerusalem as Israel’s official capital. This greatly angered the Saudis and much of the Muslim world.
The last nail in the coffin will be for Saudi Arabia to accept PetroYuan, which would break their PetroDollar agreement with the U.S..
The Crown Prince of Saudi Arabia has not struck this final nail in the coffin, but he is moving in this direction. Here’s why.
In desperate need of money, Saudi Arabia plans to IPO 5% of its state-owned oil company in the second half of 2018. (Basically selling off assets to raise cash). This will raise approximately $100 billion (Saudi Aramco is valued at $2 trillion). There’s 2 problems with this IPO.
- This is a MASSIVE IPO.
- There aren’t enough large buyers because this isn’t an attractive company.. Saudi Arabia needs oil at $75 to break even.
Who has the most cash in the world? The Chinese government. China recently announced that they will support and buy into the Saudi Aramco IPO. This is a pulic vote of confidence that’s backed up by Chinese cash.
Of course, China’s support is not free. Everything has a cost attached to it. What did China demand? China didn’t state their demands publicly, but the rumor is that China wants Saudi Arabia to accept the PetroYuan.
Saudi’s Crown Prince will have no choice but to accept China’s terms before the IPO date. Saudi Arabia is desperate for cash. They cannot hang on much longer. And Saudi Arabia no longer benefits from their alliance with the U.S. They now rely on Russia for the military and China for their economy.
The nail in the coffin, which is bullish for gold
I believe that gold will surge once Saudi Arabia announces its acceptance of the PetroYuan. Once Saudi Arabia accepts, most of the other OPEC countries will fall in line. This has to happen before the Saudi Aramco IPO in the second half of 2018.
China needs to buy massive amounts of gold to back up the Yuan. China doesn’t release their gold reserves very often, but every time they update their numbers, their gold reserves spike. China’s buying puts a wide floor under gold, which is a long term bullish factor for gold.
*Of course this doesn’t mean that gold can’t fall 10% in the medium term. This is a long term bullish factor.
How I think this will impact the U.S. Dollar
Some doomsayers think this will destroy the U.S. Dollar in the long run. I disagree. I think this will be a slow and steady long term bearish factor for the USD. I don’t think the USD will crash.
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