Death of the dollar stories surface every year. Here is another one that will likely be blown out of proportion in a number of places.
Reuters reports Xi calls for oil trade in yuan at Gulf summit in Riyadh.
President Xi Jinping told Gulf Arab leaders on Friday that China would work to buy oil and gas in yuan, a move that would support Beijing’s goal to establish its currency internationally and weaken the U.S. dollar’s grip on world trade.
Any move by Saudi Arabia to ditch the dollar in its oil trade would be a seismic political move, which Riyadh had previously threatened in the face of possible U.S. legislation exposing OPEC members to antitrust lawsuits.
China’s growing influence in the Gulf has unnerved the United States. Deepening economic ties were touted during Xi’s visit, where he was greeted with pomp and ceremony and on Friday met with Gulf states and attended a wider summit with leaders of Arab League countries spanning the Gulf, Levant and Africa.
At the start of Friday’s talks, Prince Mohammed heralded a “historic new phase of relations with China”, a sharp contrast with the awkward U.S.-Saudi meetings five months ago when President Joe Biden attended a smaller Arab summit in Riyadh.
Asked about his country’s relations with Washington in light of the warmth shown to Xi, Foreign Minister Prince Faisal bin Farhan Al Saud said Saudi Arabia would continue to work with all its partners. “We don’t see this as a zero sum game,” he said.
“We do not believe in polarisation or in choosing between sides,” the prince told a news conference after the talks.
Not a Zero Sum Game
It seems that Saudi Arabia understands something that Trump doesn’t, that Biden doesn’t, and Xi doesn’t: Trade is not a zero sum game. There are not big winners and losers as Trump believes.
Second, Reuters reported, a Saudi source told Reuters that a decision to sell small amounts of oil in yuan to China could make sense in order to pay Chinese imports directly, but “it is not yet the right time“.
Selling small amounts of anything in yuan does not do anything but allow Xi to gloat over nothing.
New International Currency
What If Amounts Were Large?
Sorry, that’s the wrong question.
First things first. We need to start with what it would take for the Yuan to become a reserve currency.
What Would It Take for the Yuan to Dethrone the Dollar?
- China would have to float the yuan.
- End capital controls
- Respect property rights
- Have a bond market big enough (China has virtually no gov’t bond market)
- Inspire global trust
- Be willing to have trade deficits
- Stop export mercantilism
- Have a currency market big enough
At a minimum, China flunks the first seven. Numbers 1, 2, 4, 6, and 7 are serious show stoppers.
Yet, every year, these stories surface. China will back the yuan with gold, China will do set up a BRIC block, China will do this or that (while this and that circulate between gold and other nonsense).
Six and seven are essentially the same point.
For all the pissing and moaning about US dollar privileges, no other country really wants to stop their export mercantilism. The two biggest players are China and Germany. Japan was once a leader in that group and squandered it.
Consumer of Last Resort
Every country wants the US consumer to remain the consumer of last resort.
Even IF that changes (someone tell me when), there are 5 critical requirements a country must meet (#s 1, 2, 4, 6- 7, 8).
The Yuan Will Not Replace the US Dollar, Nor Will It Be Backed by Commodities
I have written about this many times.
Please consider my March 15, 2022 post The Yuan Will Not Replace the US Dollar, Nor Will It Be Backed by Commodities
Like clockwork, rumors of the dollar’s demise surface several times a year. Let’s investigate the latest rumors.
Here we go again. Wake me up when China floats the yuan, has a large bond market, and is willing to run trade deficits.
This is precisely what the Saudi source meant by this is “not yet the right time“.
Pricing Unit Is Irrelevant
Meanwhile, I assure you oil trades for euros.
Regardless, the trading currency is meaningless. It’s the holding currency that matters. Currencies are fungible. It makes no difference where a swap happens.
For example, it makes no difference if Europe sells euros for dollars to buy oil, or if Saudi takes euros and one second later converts them to dollars.
A swap for yuan does not work because the yuan does not float nor is there a big Chinese bond market to challenge US treasuries.
This oil in euros idea spawned endless silliness about oil for euros being the reason for the Gulf Wars.
US Dollar Weaponized
Despite my cautions above regarding the yuan specifically, a day of reckoning is coming.
For discussion, please see Unprecedented Fed Action May Have Just Started a Global Currency Crisis
The Federal Reserve Act mandates that the Federal Reserve conduct monetary policy “so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”
Click on the link for the complete act. Nowhere does the act give the Fed the right or power to confiscate the reserves of sovereign nations.
But that is exactly what the Fed did.
In one quick order the Fed electronically rendered Russia’s foreign dollar reserves worthless, or at least unusable for now.
Currency Crisis
Over the past several years I would occasionally make a statement that were headed for a currency crisis. Every time people would ask “What will that look like?” I would answer, “I don’t know.”
Today, I have a different answer: “Read this post and understand what’s going on.” A derivatives blowup of some sort is another possibility.
We are not at a full blown crisis stage yet. And perhaps we do not get there this time.
But when trade wars like these start, history suggests major wars often follow.
Make no mistake, the US is at already war right now, but it’s economic. These trade actions and central bank sanctions are the electronic equivalent of a naval blockade.
The Fed took an unprecedented as well as illegal action on Russia that constitutes economic warfare and may easily start a currency crisis or something even worse.
It makes sense for countries to avoid US dollar confiscation. For now, avoiding dollars is still very difficult in practice for reasons stated in this post.
This post originated on MishTalk.Com.
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Mish
Here we go again! Let’s try a little thought experiment this time. Let us say the USD-Euro exchange rate is 1.25 dollars to the Euro. Let’s say we have oil at $100/barrel. And let’s say you have 800 Euros i.e. 1000 dollars at the current rates. This means you can buy 10 barrels of oil with the money. The seller of the oil can immediately convert your Euros to get the 1000 dollars that he has charged.
So far so good. Consider that oil rises to $125/barrel. At the same time, the dollar became so strong that it is now just 1 dollar to the Euro. If the seller of the oil converts your Euros to dollars now, he gets only 800 dollars for your 800 Euros. This means your money can now buy you only 6.4 barrels of oil i.e. 800/125 But if you had converted your Euros to dollars at the prior exchange rate, your cash is good for 8 barrels.
That is the reason why countries are forced to hold dollars when it is priced in dollars. They are exposed to two levels of fluctuation – 1. FX rates and 2. Oil price volatility. If they convert to dollars, they remove one of those two uncertainties.
“China would have to float the yuan.
End capital controls
Respect property rights
Have a bond market big enough (China has virtually no gov’t bond market)
Inspire global trust
Be willing to have trade deficits
Stop export mercantilism
Have a currency market big enough”
I still have no idea where these supposedly necessary conditions for being a trading/reserve currency comes from…. Unless a tablet or two went missing, it sure wasn’t from Moses….
America blatantly violates 2,3 and 5. So those are obviously not necessary. At least for maintaining trading/reserve currency status. Perhaps for becoming a trading/reserve currency? America wasn’t quite such a basket case back in the days when the Dollar gained its current status. There is something to the notion that it could take a good bit more trust for “the world” to make a serious concerted change; than for it to continue with what is already there; even of the latter is obviously no longer ideal.
A big bond market is trivially only a good thing as long as the debt is serviced without creditors losing too much. With America producing nothing of value whatsoever; aside from ever more empty promises of a better tomorrow; that obviously can’t go on forever. The Dollar gained its position back when debt was being paid down. Not continually ran up in an ever accelerating fashion.
Ditto trade deficits: It’s trivially absurd to believe that guaranteed 100% trade deficits, for all future, would ever strengthen a national currency’s candidacy as a world reserve currency. Dollar holders hold dollars with the built in expectation of getting something, anything; other than just paper; back at some point. In at least some possible future. “Guaranteed infinite trade deficits forever” will never be a selling point for reserve currency status. Again; the Dollar gained its status back when debt was being retired. Not racked up at ever greater rates just to maintain some temporary illusion of solvency.
As for “export mercantilism”: A population which saves; does not render their national currency somehow less suitable as a reserve currency; than a population which makes nothing but instead burns everything their grandparents once made; then burns some more lent them on credit. Quite the opposite. And again: Americans once worked, produced and saved. That’s when the Dollar took on reserve currency status. Not once they all retired to a life of robbing others via debasement instead.
“Currency market big enough” is important in a genuinely multipolar world, where you trade with people ultimately needing to convert to all manners of other currencies. If virtually all you need and want is produced better and cheaper in China than anywhere else; holding Yuan is quite sufficient. Ditto as for floating the Yuan. That may be overstating things a bit; but if everyone other than China you need to trade with mostly will use your funds to buy stuff from China, that still severely limits the size of the currency market necessary for supporting such trade. A good case can be made that current currency markets are indeed vastly, grossly inefficiently, oversized; since they mostly serve as staging areas to facilitate the only trade which really matters: That of Dollars to yuan and back: What people really want is Chinese stuff. So they need Yuan. But the need Dollars to get Yuan………. Ultimately pointless middlemen are hardly efficient in the long run.
In reality: Like the Pound in its waning years: The Dollar remains the reserve currency because of factors America once possessed, but no longer do: Specifically, because everyone needed to buy stuff from America. Hence needed lots of Dollars. Now, like the late Pound, people use Dollars because they once used to use Dollars, and change; particularly coordinated change between multiple parties; is hard. Noone wants to be first mover, since it’s awkward to trade in Martian Musks, when noone else does. But the factors that once led to the Dollar’s preference in the first place; are now almost all more prevalent China than the US. The Chinese real economy hegemony may not be quite as overwhelming as the US one at the end of WW2 when everywhere else where bombed flat; but it’s growing every day. Ensuring that sticking with the Dollar gets costlier and costlier, and riskier and riskier, every day. That _will_ lead to some, at the edges and fringes, jumping ship. And it will happen like all changes to network centered nodels: First in a slow trickle, then all at once. Which “just happened. Noone could possibly foresee it” being spouted by the usual clowns once it does.
You don’t have to be a petroleum engineer to understand what is going on. But you have to be out of touch with reality if you think that Green River will be accessed in any meaningful way in the next decade.