The demise of the petro-dollar

Russia is preparing to sell its oil for anything but dollars. Meanwhile the collapse of the oil price is forаing financial reality on the Kingdom of Saud.

Taking The 'Petro' Out Of The Dollar

Submitted by Alasdair Macleod via GoldMoney.com,

Zero Hedge,

30 April, 2016

Saudi Arabia has been in the news recently for several interconnected reasons. Underlying it all is a spendthrift country that is rapidly becoming insolvent.

While the House of Saud remains strongly resistant to change, a mixture of reality and power-play is likely to dominate domestic politics in the coming years, following the ascendency of King Salman to the Saudi throne.This has important implications for the dollar, given its historic role in the region.

Last year’s collapse in the oil price has forced financial reality upon the House of Saud. The young deputy crown prince, Mohammed bin Salman, possibly inspired by a McKinsey report, aims to diversify the state rapidly from oil dependency into a mixture of industries, healthcare and tourism. The McKinsey report looks like a wish-list, rather than reality, particularly when it comes to tourism. The religious police are unlikely to take kindly to bikinis on the Red Sea’s beeches, or to foreign women in mini-shorts wandering around Jeddah.

It is hard to imagine Saudi Arabia, culturally stuck in the middle ages, embracing the changes recommended by McKinsey, without fundamentally reforming the House of Saud, or even without a full-scale revolution. Nearly all properties and businesses are personally owned or controlled by members of the extended royal family, not the state, nor by lesser mortals. The principal exception is Aramco, estimated to be worth $2 trillion.

The state is subservient to the House of Saud. It is therefore hard to see how, as McKinsey recommends, the country can “shift from its current government-led economic model to a more market-based approach”. The country is barely government led: a puppet of the Saudis is more like it. But the state’s lack of funds is making it increasingly desperate.

It was for this reason the Kingdom recently placed a $10bn five-year syndicated loan, the first time it has entered capital markets since Saddam Hussein invaded Kuwait. It proposes to raise a further $100bn by selling a 5% stake in Aramco. The financial plan appears to be a combination of this short-term money-raising, contributions from oil revenue, and sales of US Treasuries (thought to total as much as $750bn). The government has, according to informed sources, been secretly selling gold, mainly to Asian central banks and sovereign wealth funds. Will it see the Kingdom through this sticky patch?

Maybe. Much more likely, buying time is a substitute for ducking fundamental reform. But one can see how stories coming out of Washington, implicating Saudi interests in the 9/11 twin-towers tragedy, could easily have pulled the trigger on all those Treasuries.

Whatever else was discussed, it seems likely that this topic will have been addressed at the two special FOMC meetings “under expedited measures” at the Fed earlier this month, and then at Janet Yellen’s meeting with the President at the White House. This week’s holding pattern on interest rates would lend support to this theory.

The White House’s involvement certainly points towards a matter involving foreign affairs, rather than just interest rates. If the Saudis had decided to dump their Treasuries on the market, it would risk collapsing US bond markets and the dollar. Through financial transmission, euro-denominated sovereign bonds and Japanese government bonds, all of which are wildly overpriced, would also enter into free-fall, setting off the global financial crisis that central banks have been trying to void.

Perhaps this is reading too much into Saudi Arabia’s financial difficulties, but the possibility of the sale of Treasuries certainly got wide media coverage. These reports generally omitted to mention the Saudi’s underlying financial difficulties, which could equally have contributed to their desire to sell.

While the Arab countries floated themselves on oceans of petro-dollars forty years ago, they have little need for them now. So we must now turn our attention to China, which is well positioned to act as white knight to Saudi Arabia. China’s SAFE sovereign wealth fund could easily swallow the Aramco stake, and there are good strategic reasons why it should. A quick deal would help stabilise a desperate financial and political situation on the edges of China’s rapidly growing Asian interests, and keep Saudi Arabia onside as an energy supplier. China has dollars to dispose, and a mutual arrangement would herald a new era of tangible cooperation. The US can only stand and stare as China teases Saudi Arabia away from America’s sphere of influence.

In truth, trade matters much more than just talk, which is why a highly-indebted America finds herself on the back foot all the time in every financial skirmish with China. Saudi Arabia has little option but to kow-tow to China, and her commercial interests are moving her into China’s camp anyway. It seems logical that the Saudi riyal will eventually be de-pegged from the US dollar and managed in line with a basket of her oil customers’ currencies, dominated by the yuan.

Future currency policies pursued by both China and Saudi Arabia and their interaction will affect the dollar. China wants to use her own currency for trade deals, but must not flood the markets with yuan, lest she loses control over her currency. The internationalisation of the yuan must therefore be a gradual process, supply only being expanded when permanent demand for yuan requires it. Meanwhile, western analysts expect the riyal to be devalued against the dollar, unless there is a significant and lasting increase in the price of oil, which is not generally expected. But a devaluation requires a deliberate act by the state, which is not in the personal interests of the individual members of the House of Saud, so is a last resort.

It is clear that both Saudi Arabia and China have enormous quantities of surplus dollars to dispose in the next few years. As already stated, China could easily use $100bn of her stockpile to buy the 5% Aramco stake, dollars which the Saudis would simply sell in the foreign exchange markets as they are spent domestically. China could make further dollar loans to Saudi Arabia, secured against future oil sales and repayable in yuan, perhaps at a predetermined exchange rate. The Saudis would get dollars to spend, and China could balance future supply and demand for yuan.

It would therefore appear that a large part of the petro-dollar mountain is going to be unwound over time. There is now no point in the Saudis also hanging onto their US Treasury bonds, so we can expect them to be liquidated, but not as a fire-sale. On this point, it has been suggested that the US Government could simply block sales by China and Saudi Arabia, but there would be no quicker way of undermining the dollar’s international credibility. More likely, the Americans would have to accept an orderly unwinding of foreign holdings.

The US has exploited the dollar’s reserve currency status to the full since WW2, leading to massive quantities of dollars in foreign ownership. The pressure for dollars to return to America, when the Vietnam war was wound down, was behind the first dollar crisis, leading to the failure of the London gold pool in the late sixties. After the Nixon Shock in 1971, the cycle of printing money and credit for export resumed.

In the seventies, higher oil prices were paid for by printing dollars and by expanding dollar bank credit, in turn kept offshore by lending these exported dollars to Latin American dictators. That culminated in the Latin American debt crisis. From the eighties onwards, the internationalisation of business was all done on the back of yet more exported dollars, and wars in Iraq and Afghanistan echoed the earlier wars of Korea and Vietnam.

Many of these factors have now either disappeared or diminished. For the last eighteen months, the dollar had a last-gasp rally, as commodity and oil prices collapsed. The contraction in global trade since mid-2014 had signalled a swing in preferences from commodities and energy towards the money they are priced in, which is dollars. The concomitant liquidation of malinvestments in the commodity-exporting countries has been contained for now by aggressive monetary policies from China, Japan and the Eurozone. The tide is now swinging the other way: preferences are swinging out of the dollar towards oversold commodities again, exposing the dollar to a second version of the gold pool crisis. This time, China, Saudi Arabia and the BRICS will be returning their dollars from whence they came.

In essence, this is the market argument in favour of gold. Over time, the price of commodities and their manufactured derivatives measured in grams of gold is relatively stable. It is the price measured in fiat currencies that is volatile, with an upward bias. The price of a barrel of oil in 1966, fifty years ago, was 2.75 grams of gold. Today it is 1.0 gram of gold, so the purchasing power of gold measured in barrels of oil has risen nearly three-fold. In dollars, the prices were $3.10 and $40 respectively, so the purchasing power of the dollar measured in barrels of oil has fallen by 92%. Expect these trends to resume.

This is also the difference between sound money and dollars, which has worked to the detriment of nearly all energy and commodity-producing countries. With a track-record like that, who needs dollars?

It is hard to see how the purchasing power of dollars will not fall over the rest of the year. The liquidation of malinvestments denominated in external dollars has passed. Instead, the liquidation of financial investments carry-traded out of euros and yen is strengthening those currencies. That too will pass, but it won’t rescue the dollar.

Dollar, good-bye: Russia will sell oil for rubles

Доллар, гуд-бай: Россия будет продавать нефть за рубли

Politpuzzle,

30 April, 2016

Ongoing reformatting of the domestic economy, finally came to the oil market. Yesterday, the Russian experts in an interview with Bloomberg was made an interesting statement.

After months of preparation Russia launches its own production of financial document for independent implementation of Urals oil. Thus, it will create an open system in which the oil is valued most fairly. Bidding will be held at the St. Petersburg international Mercantile exchange (SPIMEX) and negotiations are underway to establish cooperation with foreign partners.

By the way, SPIMEX is the largest Russian oil exchange platform, created in 2008 after the Government ordered companies to sell mandatory 5-10 per cent produced domestically. Annual turnover for 2015 of around 533 billion rubles ($7.8 billion), or more than 15 percent of the total fuel supplied to the domestic market

But most importantly, the rejection of pricing in dollars. From now on, Urals will be traded in the Russian national currency. This innovation will reduce the impact of fluctuating oil prices and stabilizes the market. Will also be reduced costs because you'll fail from the intermediate dollar currency.

Now, in order to attract traders, the Bank of Russia is preparing amendments to the legislation for granting foreign firms access to commodities and their derivatives.

"Russia is doing what failed other: the dollar loses its security of oil contracts. In the medium term, Moscow will increase revenues from oil sales. Piping to bypass the dollar of the enormous flow of trade, the authorities will seek to reduce the credibility of the us dollar and boost demand for the ruble, killing two birds with one stone".

This practice is the transfer of trade of petroleum operations on the national currency is not new. Norway concludes his transactions, only using the inner crown, saving yourself from a lot of expenses and risks, but at the same time strengthening currency in the global market.

Therefore, the Government of the Russian Federation makes a very thoughtful, and correct strategic move in the near future will show its fruits and positively affect the lives of every Russian.

…..

Продолжающееся переформатирование отечественной экономики, наконец, дошло и до нефтяного рынка. Вчера российскими экспертами в интервью агентству Bloomberg было сделано весьма занимательное заявление.

После многомесячной подготовки Россия запускает собственный производственный финансовый документ для независимой реализации нефти марки Urals. Таким образом, будет создана отрытая система, в которой нефть оценивается максимально справедливо. Торги будут проводиться на базе Санкт-Петербургской международной товарно-сырьевой биржи (СПбМТСБ) и сейчас ведутся переговоры по налаживанию сотрудничества с зарубежными партнерами.

К слову, СПбМТСБ — крупнейшая в России нефтяной платформа-биржа, созданная в 2008 году после того как Правительство обязало компании продавать обязательные 5-10 процентов добытого внутри страны. Годовой товарооборот за 2015 — около 533 миллиарда рублей (7,8 миллиарда долларов), или более чем 15 процентов всего топлива, поставляемого на внутренний рынок

Но главное, отказ от ценообразования в долларах. Отныне, Urals будет торговаться за российскую национальную валюту. Подобное нововведение позволит снизить влияние колеблющихся цен на нефть и стабилизирует рынок. Также будут снижены издержки, поскольку произойдет отказ от промежуточной, долларовой валюты.

Сейчас, для того, чтобы привлечь трейдеров, Банк России готовит поправки в законодательство о предоставлении иностранным фирмам доступа к биржевым товарам и их производных.

«Россия делает то, что не получилось у других: доллар лишается основы своего обеспечения — нефтяных контрактов. В среднесрочной перспективе Москва увеличит доходы от продажи нефти. Пуская в обход доллара колоссальные потоки товарооборота, власти будут стремиться уменьшить авторитет американской валюты и повышать спрос на рубль, убивая сразу двух зайцев».

Подобная практика перевода торговых нефтяных операций на национальную валюту не нова. Норвегия заключает свои сделки, используя лишь внутреннюю крону, избавляя себя от множества расходов и рисков, а заодно укрепляя валюту на мировом рынке.

Посему, Правительство РФ делает весьма продуманный, правильный и стратегический шаг, который уже в ближайшем будущем покажет свои плоды и благотворно отразится на жизни каждого россиянина.

Decoupling

Decoupling is happening, and it is happening fast.

Unlike America Russia doesn't threaten but acts and often (as in counter-sanctions) the response comes from left field (at least for the idiots in Brussels and Washington).

Kama.

Russia Just Pulled Itself Out Of The Petrodollar

Zero Hedge,

14 January, 2015

Back in November, before most grasped just how serious the collapse in crude was (and would become, as well as its massive implications), we wrote "How The Petrodollar Quietly Died, And Nobody Noticed", because for the first time in almost two decades, energy-exporting countries would pull their "petrodollars" out of world markets in 2015. 

This empirical death of Petrodollar followed years of windfalls for oil exporters such as Russia, Angola, Saudi Arabia and Nigeria. Much of that money found its way into financial markets, helping to boost asset prices and keep the cost of borrowing down, through so-called petrodollar recycling.

We added that in 2014 "the oil producers will effectively import capital amounting to $7.6 billion. By comparison, they exported $60 billion in 2013 and $248 billion in 2012, according to the following graphic based on BNP Paribas calculations."

The problem was compounded by its own positive feedback loop: as the last few weeks vividly demonstrated, plunging oil would lead to a further liquidation in foreign  reserves for the oil exporters who rushed to preserve their currencies, leading to even greater drops in oil as the viable producers rushed to pump out as much crude out of the ground as possible in a scramble to put the weakest producers out of business, and to crush marginal production. Call it Game Theory gone mad and on steroids.

Ironically, when the price of crude started its self-reinforcing plunge, such a death would happen whether the petrodollar participants wanted it, or, as the case may be, were dragged into the abattoir kicking and screaming.

It is the latter that seems to have taken place with the one country that many though initially would do everything in its power to have an amicable departure from the Petrodollar and yet whose divorce from the USD has quickly become a very messy affair, with lots of screaming and the occasional artillery shell.

As Bloomberg reports Russia "may unseal its $88 billion Reserve Fund and convert some of its foreign-currency holdings into rubles, the latest government effort to prop up an economy veering into its worst slump since 2009."

These are dollars which Russia would have otherwise recycled into US denominated assets. Instead, Russia will purchase even more Rubles and use the proceeds for FX and economic stabilization purposes. 

"Together with the central bank, we are selling a part of our foreign-currency reserves,” Finance Minister Anton Siluanov said in Moscow today. “We’ll get rubles and place them in deposits for banks, giving liquidity to the economy."

Call it less than amicable divorce, call it what you will: what it is, is Russia violently leaving the ranks of countries that exchange crude for US paper.

More:

Russia may convert as much as 500 billion rubles from one of the government’s two sovereign wealth funds to support the national currency, Siluanov said, calling the ruble “undervalued.” The Finance Ministry last month started selling foreign currency remaining on the Treasury’s accounts.

The entire 500 billion rubles or part of the amount will be converted in January-February through the central bank, according to Deputy Finance Minister Alexey Moiseev. The Bank of Russia will determine the timing and method of the operation.

The ruble, the world’s second-worst performing currency last year, weakened for a fourth day, losing 1.3 percent to 66.0775 against the dollar by 3:21 p.m. in Moscow. It trimmed a drop of as much as 2 percent after Siluanov’s comments. The ruble’s continued slump this year underscores the fragility of coordinated measures by Russia’s government and central bank that steered the ruble’s rebound from a record-low intraday level of 80.10 on Dec. 16. OAO Gazprom and four other state-controlled exporters were ordered last month to cut foreign-currency holdings by March 1 to levels no higher than they were on Oct. 1. The central bank sought to make it easier for banks to access dollars and euros while raising its key rate to 17 percent, the emergency level it introduced last month to arrest the ruble collapse.

Today’s announcement “looks ruble-supportive, as together with state-driven selling from exporters it would support FX supply on the market,” Dmitry Polevoy, chief economist for Russia and the Commonwealth of Independent States at ING Groep NV in Moscow, said by e-mail. “Also, it will be helpful for banks, while there might be some negative effects related to extra money supply and risks of using some of the money on the FX market for short-term speculations.

Bloomberg's dready summary of the US economy is generally spot on, and is to be expected when any nation finally leaves, voluntarily or otherwise, the stranglehold of a global reserve currency. What Bloomberg failed to account for is what happens to the remainder of the Petrodollar world. Here is what we said last time:

Outside from the domestic economic impact within EMs due to the downward oil price shock, we believe that the implications for financial market liquidity via the reduced recycling of petrodollars should not be underestimated. Because energy exporters do not fully invest their export receipts and effectively ‘save’ a considerable portion of their income, these surplus funds find their way back into bank deposits (fuelling the loan market) as well as into financial markets and other assets. This capital has helped fund debt among importers, helping to boost overall growth as well as other financial markets liquidity conditions.

...

[T]his year, we expect that incremental liquidity typically provided by such recycled flows will be markedly reduced, estimating that direct and other capital outflows from energy exporters will have declined by USD253bn YoY. Of course, these economies also receive inward capital, so on a net basis, the additional capital provided externally is much lower. This year, we expect that net capital flows will be negative for EM, representing the first net inflow of capital (USD8bn) for the first time in eighteen years. This compares with USD60bn last year, which itself was down from USD248bn in 2012. At its peak, recycled EM petro dollars amounted to USD511bn back in 2006. The declines seen since 2006 not only reflect the changed global environment, but also the propensity of underlying exporters to begin investing the money domestically rather than save. The implications for financial markets liquidity - not to mention related downward pressure on US Treasury yields – is negative.

Considering the wildly violent moves we have seen so far in the market confirming just how little liquidity is left in the market, and of course, the absolutely collapse in Treasury yields, with the 30 Year just hitting a record low, this prediction has been borne out precisely as expected.

And now, we await to see which other country will follow Russia out of the Petrodollar next, and what impact that will have not only on the world's reserve currency, on US Treasury rates, and on the most financialized commodity as this chart demonstrates...

... but on what is most important to developed world central planners everywhere: asset prices levels, and specifically what happens when the sellers emerge into what is rapidly shaping up as the most illiquid market in history

Sanctions blowback?

"Russian Buyer Is A Thing Of The Past" - Oligarchs Rush To Sell US Real Estate

Zero Hedge,

14 January, 2015

For uber-wealthy Russians, "an apartment in Miami, even the most glorious beachfront apartment, is not a priority right now," warns one real estate attorney, as The New York Observer reports Russian buyers no longer felt they had the liquid assets to carry on with the transaction and were looking to break closed real estate contracts. "Your average Russian buyer tends to be someone who works in the $5, $10, $15 million range. Obviously very wealthy people, but also people who are much more likely to feel a pinch given the economic situation and the exchange rate," and with maintenance costs sky-high, the trophy apartments have shifted from 'safe-deposit-boxes' out of reach of sanctions to burdensome drains.

As The New York Observer reports,

Just before the holidays, a handful of unusual business proposals made their way to the desk of Marlen Kruzhkov, an attorney at New York’s Gusrae Kaplan: Russian buyers were looking to flip closed real estate contracts.

...

The buyers who approached the attorney and his clients had placed sizable down payments on the apartments but following Russia’s increased economic woes, no longer felt they had the liquid assets to carry on with the transaction.

...

“They were offering to sell the contract at a loss, willing to take a fifty percent loss on a down payment as not to take a hundred percent loss. Due to the exchange rate, they did not have the liquidity to finish the transaction,” Mr. Kruzhkov told the Observer. Second and in some cases third homes of this kind stopped being a priority for Russian buyers. “An apartment in Miami, even the most glorious beachfront apartment, is not a priority right now.”

Troubles with Russian buyers have also found their way to the New York real estate market, materializing in a slightly different way as buyers look to escape contracts during the negotiation process. Several wealthy Russian buyers canceled deals based on Russia’s increasingly strained relationship with the western world. “I have had Russian clients who were about to purchase properties in New York change their minds within days of Russian occupying Ukraine,” attorney Petro Zinkovetsky told the Observer. One of the buyers was purchasing a $10 million home; another was looking to spend over $17 million. Mr. Zinkovetsky promptly canceled both deals.

While the stereotypical Russian buyer is a billionaire handing over a briefcase of cash for a park view penthouse, the true buyer is a millionaire who considers both financing options and bustling downtown lofts. Billionaires unaffected by the stumbling ruble are, in fact, infrequent buyers in the American real estate market compared to mid-range millionaires.

“Your average Russian buyer tends to be someone who works in the $5, $10, $15 million range. Obviously very wealthy people, but also people who are much more likely to feel a pinch given the economic situation and the exchange rate,” Mr. Kruzhkov explained.

As that pinch becomes increasingly uncomfortable, Russian buyers consider less expensive apartments they can rent out more easily in neighborhoods that may have previously been overlooked.

Even Russian buyers who purchased trophy apartments in the city years ago are now looking to rent them out.

A client of Mr. Zinkovetsky’s has owned a New York apartment for two years but spent only five collective weeks in the space. Last month, he decided it was time to rent it in an effort to level out the increasingly burdensome maintenance costs. 

“[Russian buyers] view United States real estate as a ‘safe deposit box’ that occasionally comes with a good view. Their objective is to move money out of their home country and safeguard their assets by placing them in the U.S. real estate… [But] at this point, it becomes expensive to maintain a ‘safe deposit box’.”

* * *

Sanctions blowback?

The move away from the dollar intensifying

The move away from the dollar is intensifying. Given the recent obvious deterioration in U.S. prestige and clout internationally I would say that a global dollar exodus is inevitable now and the dollar is only going to get weaker. Translation" hyperinflation. -- MCR

China Is About To Take A HUGE Step Toward Internationalizing Its Currency

Business Insider, 8 March, 2012

Last year, Chinese officials reportedly told EU members that the renminbi would be fully convertible by 2015. And recently, Chinese central bank governor Zhou Xiaochan said China is not too far away from its goal of yuan convertibility.

With Hong Kong already trading offshore yuan, and London hoping to take over that mantle in the coming years, China may just have taken another step toward making its currency convertible.

The China Development Bank initiative

China now plans to offer renminbi loans to other BRICS nations Brazil, Russia, India and South Africa, the Financial Times reported. The China Development Bank (CDBs) will reportedly sign a memorandum of understanding (MoU) in New Delhi with its BRICS counterparts on March 29. The five dominant emerging economies are signing the initiative in an effort to boost trade and promote the use of the renminbi for international trade over the dollar.

China first made the yuan convertible for trade settlement back in 1996. As of now 13 percent of China's trade in Asia is conducted in renminbi, but the renminbi's share of regional trade is slated to rise to 50 percent by 2015, according to HSBC. The renminbi's greater role in financing trade could also be a huge advantage for China since it forces other countries to take on the risk of adverse currency moves.

The internationalization of the yuan

Earlier this year Deutsche Bank analyst Alan Cloete said the renminbi is expected to become a major reserve currency in the next decade. He expects the U.S. dollar's share of the global reserve currency basked to fall from about 60 percent now, to 50 percent by 2020.

And signs of this are already apparent. First, many countries have been diversifying their foreign reserves to include the renminbi because they expect the currency to strengthen and eventually become a reserve currency. 0.3 percent of Chile's foreign reserves are held in renminbi. In September last year, major oil player Nigeria said it would diversify five to 10 percent of its foreign exchange reserves to include the yuan.

Second, China has expressed its interest in adding the renminbi to the IMF's Special Drawing Rights (SDR) currency basket, as a reserve currency. CDBs initiative if it goes through will only speed up the process.

At The Rise of the Renminbi conference, Hongbin Qu, HSBC's managing director said:

"The pace of the renminbi internationalization has been much faster than almost everybody expected in the last few years. We're expecting this trend to continue. In the next two to three years we expect the renminbi to become one of the top three global currencies being used in global trade."

For the renminbi to become fully convertible however, it would have to appreciate to fair market value and the government would have to cede some control of its financial markets. 

But it's unclear how likely this is. After all, PBOC governor Zhou recently said that currency convertibility doesn't mean surrendering control of cross-border financial transactions