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Table of Contents
The Petro-dollar begins to Fall… Slowly
Economic Calendar
Kuroda’s Replacement
FOMC Minutes
Crypto Macro
Price Action
CEx Liquidity Risk
Conclusion
Internal References
1. The Petro-dollar begins to Fall… Slowly
No doubt you have probably been seeing a significant number of headlines about France making a deal to sell LNG in Chinese Yuan, The Saudi’s joining the Shanghai Cooperation Organization as a Dialogue Partner or general rumblings that the Saudi’s deal to build an oil refinery in China for Russian heavy crude are indicative that the Petro-dollar will die in a few weeks or a month.
While these people are talking about an important economic and geopolitical inevitability, they are indelicate, lacking nuance, and just the catastrophe bros who move from one topic to another to farm engagement on social media.
There is one very easy way to tell that the Petro-dollar has not been threatened yet… we haven’t started a war with China.
As I said previously; whoever loses the economic war will start the shooting war.
Are the Saudis about to start selling oil in Chinese Yuan instead of dollars? First of all, as we discussed last year the Saudi currency is pegged to the US dollar.
You may have heard rumblings recently from South Africa that Saudi Arabia wants to join BRICS. We discussed this possibility here back in June when it was news. The announcement was at the time made public as a threat to the west after Russian visits to the kingdom in May. But I don’t think Saudi Arabia will overtly join BRICS until after the move to de-dollarize is nearly complete. The Saudi currency (the Riyal) is pegged to the US Dollar. They reap just as much benefit from the petro-dollar as we do, but considering they are the ones doing all of the work, it doesn’t make much sense for them to be sharing this benefit with us. Currently the Saudi’s biggest export partner for oil is China (naturally), who is paying for these oil imports in dollars. China has made several attempts to invoice this in Yuan, but has only been able to force yuan invoicing for oil China refines itself (they have some deals with Saudi Aramco for this). Despite the US’s geopolitical unpopularity, the Saudi’s have no reason to give up this competitive advantage to China, and so long as the strong dollar trade is occurring, the Saudi’s have no reason to de-peg their currency from the dollar.
Since that post, we have gotten closer to the end of the strong dollar trade as we are nearing the end of this credit cycle. But we still have yet to see the Saudis make any move to depeg the Riyal from the dollar. As a move this would take months to unwind as the process to peg a currency to the dollar requires open market operations, futures contracts, and arbitrage with deep liquidity across multiple Fx markets. It’s not a snap your fingers and you’re done kind of thing. We haven’t even seen a hint that they have started to make this move just yet.
This next bit comes as a surprise to most people, but the Chinese Yuan is pegged to the US Dollar. The Yuan used to have a hard peg to the dollar until 2010, at which point the Chinese loosened up and allowed the Yuan to trade within a narrow band.
Hard pegs for currency are retarded, and it’s quite likely that the actual exchange rate for the Yuan experienced significant slippage or very large spreads while the government was wasting money maintaining a hard peg which would have heavily impacted their export sector.
Allowing the Yuan to trade in a band probably allowed for much tighter exchange rates while simultaneously costing the central bank far less.
Since the Chinese Yuan is no longer hard-pegged to the USD it would be easier for them to move away from a dollar-centric society by just widening this band or no longer interfering in the exchange rate, but we won’t see an end to the petro-dollar until Saudi Arabia moves to de-peg their currency from the USD.
And it’s very likely that such a move would mark the beginning of a war. They likely won’t tell us the war is over the dollar. It’ll instead be about China threatening Taiwan, attacking Vietnamese fishing ships as China violates the Vietnamese EEOZ, or maybe the US will send the 400th delegation to Taiwan and the plane will get shot down (a traditional Muslim sea burial, if you will) and we blame it on China. Who knows? I don’t, but I do know that the petro-dollar will not end with a whimper, it will end with a bang.
And this makes sense. If someone breaks into your house and you have 12 guns in your closet, you aren’t going to just let the guns sit there. The petro-dollar is our house, and we have the Army, Navy, Marines, Air Force, and Space Force in our closet. If it comes to that shots will be fired.
We killed Gaddafi over far less.
Gaddafi was sodomized in the street with a bayonet and shot multiple times. There are no limits to what we would attempt in order to protect the petro-dollar from a legitimate attempt at dethroning.
This means two things. One, the real threat hasn’t emerged yet. Two, any attempt to legitimately dethrone the petro-dollar will not be done frivolously.
When you aim at the king, you best not miss. When/If China convinces Saudi Arabia and OPEC to invoice for oil in yuan, gold, or any other currency other than the dollar, it will be done alongside a number of other moves to de-dollarize and separate the euro-dollar from the forex dominance it currently has which we discussed last year.
In the quote above, we can see that the Euro and US Dollar in 2016 accounted for 69% (nice) of invoicing for all exports in 2016. When including the petro-dollar (below in orange), US dollar and Euro invoicing dominance averaged from 1999 to 2019 was 84%.
84%
This is the great Satan when viewed from an Eastern Lens.
So while a lot of the petro-dollar news is just noise coming from disaster merchants trying to get you to buy gold right now with 100% of your savings, there were still some interesting developments out of China.
China managed to broker renewed diplomatic relations between Saudi Arabia and Iran. This is significant as there has been a rift in the Muslim world for the last several decades. There are 2 major sects in the Muslim world. Sunni and Shia. The Shias believe in the divinity of the bloodline of the prophet Mohammed, while the Sunni Muslims tend to oppose this train of thought. But just like everything else in life, it’s fractal all the way down. Within these two major branches, there are multiple sects all fighting with each other. Despite the original generation of children of Mohammed primarily residing in Saudi Arabia, Saudi Arabia is now a Sunni country (specifically the Wahhabist sect). While Iran is ruled by Shias. The two have has been at odds over this fact since the 70s and tensions have been high. There has been much discussion about Iran supporting Shia militant groups in Yemen, while Saudi Arabia has been accused of funding Wahhabist Sunni militants in Iran, Iraq, Turkey, and elsewhere.
One could make an argument that there are and have been ongoing proxy wars between the two that have been exacerbated by the petro-dollar and the Western desire for oil pipelines to cross this space. The West didn’t start any of these conflicts, they have existed as a side effect of the expansion of the Arab caliphates, the Persian and Ottoman sultanates, and then European colonialism after the collapse of the Ottoman empire. That is a whole ‘nother subject entirely though. I have no doubt college dissertations have been written about the British mistakes in drawing the Kuwaiti-Iraq border were a direct cause of the Gulf War and US invasion of Iraq or the collapse of the Ottoman Empire, and British ignorance leaving no appropriate sovereign state where Kurdistan should be. We can speak of how Afghanistan is a pretend country of arbitrary lines penning multiple tribal and ethnic groups into a single government when they really should have half a dozen.
But this isn’t a map porn substack, so let’s get back on topic. The re-opening of diplomatic communication between Iran and Saudi Arabia is a huge accomplishment. This could lead to the end of the ongoing conflict and humanitarian crisis in Yemen. Not only does this also mean that middle eastern diplomacy is more likely to flow through China and consider Chinese needs, but that it also will not flow through the US and be less considerate of Western needs in general. We’ve already discussed how Iran was sanctioned and removed from the SWIFT system in the 2010s. They can only trade globally through the Chinese CIPS system and the Russian SPFS.
but in 2012 the US specifically twisted SWIFT’s arm to get them to remove several Iranian banks from the SWIFT system. This was ostensibly part of a pressure program that was accusing Iran of making nuclear weapons. Of course, it’s been 10 years now and we know that was a lie, which led to a devaluation of the Iranian currency by 80%, the collapse of many businesses and the exit of many corporations that had been providing jobs to Iranian citizens. These sanctions also made it nearly impossible to maintain insurance on shipping vessels stopping in Iranian ports, so imports and exports collapsed as even if you were shipping pallets of cash or Gold, the ships still wouldn’t come to port. Medicinal products aren’t subject to sanctions, but medical imports collapsed because the ships couldn’t dock and medical companies couldn’t get paid, so many medical conditions, like HIV/AIDS, hemophilia, diabetes, cancer, multiple sclerosis, and others are no longer able to be treated in Iran. These sanctions are still in place today, and it’s estimated that over $100 Billion of Iranian assets were frozen as a result of these sanctions, no estimates for how much value was destroyed in the Iranian economy, nor how many people died, families starved, and lives never started.
Through no choice of their own, China and Russia are Iran’s only lifeline when it comes to importing goods, insuring their naval trade, and allowing the economy to function.
The more China can get this section of the world to look to China first and consider Chinese systems when it comes to trade and commerce, the more prepared and willing they will be to feel strong enough in numbers to ditch the petro-dollar at once.
It’s one thing for China to get countries to agree to use the Yuan when China is buying goods. It will be quite another for them to get an entire bloc of countries to agree to use the Yuan, or another currency when trading with each other.
That will be the move, and we are still far off from that. Do you want my rough back of the napkin guess? China is still 5-6 years away from being able to do that. Could be sooner if things go poorly in the West, or could be later/never if the demographic time bomb in China detonates.
The main bottleneck from them isn’t import partners, it’s military force. Despite what many people want you to believe, China has a joke of a military. Outside of land battles and having cities that are essentially un-siegable, China has few advantages in a legitimate war with the West.
Their biggest disadvantage is that they are wholly dependent on naval trade for food and oil imports. Without this naval trade, China would starve, freeze, and its economy would come to a grinding halt.
While China did surpass the US and now has the largest Navy as of 2021, China’s Navy is a joke.
As we covered last year, they use old tech that is vulnerable to supply cuts.
Consider that China does not have a single nuclear powered vessel in their navy, they are all diesel powered. This technology is 90 years old. The US and other modern navies began shifting to nuclear powered vessels in the 1950’s because it provided a massive improvement to operational effectiveness by eliminating the need to refuel nearly as often and allowed for significantly more storage space on board for food and fresh water allowing the crews to stay out of port for significant periods of time if necessary. China would essentially be cut off from the Malacca Straight past Singapore and have no operational effectiveness in the pacific ocean to protect any export trading vessels once they’ve sailed a few hundred miles from Chinese shorelines. Meaning all of their sea trade to Africa, Europe, and South America would be cut-off. While China has stores of grain and fuel for a significant time, their economy would likely stagnate significantly under such an embargo and it would be political suicide for Xi.
If China finds some way to engage/invade Taiwan, they will have to do it delicately, or bide their time because they simply do not have the naval assets to engage the west directly.
Secondly, when comparing navies you can do it by counting ships, or by counting weight. The US Navy has 4.6 million tons of ships in its fleet. The Chinese Navy barely has 2 tons of ships in its fleet.
When you state this difference in 2 short sentences it looks like this. China is running hundreds of tiny ships using 100-year-old diesel reactors requiring constant refueling. The US is running hundreds of large ships using mostly semi-modern nuclear reactors that require very little refueling.
China has no means by which to defend the most vulnerable part of its supply chain from a naval blockade.
They can either build a navy to compete with the US and its Western allies or China can decrease its dependence on naval trade for key resources.
In terms of oil, I haven’t really seen China do too much to signal they genuinely are shifting their supply chain away from their ports. China’s newest deal with Saudi Aramco is to build more refinery capacity and a 300-ton wharf in a North Eastern Port City. China isn’t stupid. They’re not going to build this just to get blind-sided by a US naval blockade. Their continued naval infrastructure development is a sign of only one thing.
Their strike against the petro-dollar is not imminent. It’s still years away.
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