The Saudis and the 'Petrodollar Deal'

Several days ago, there were stories that a supposed US-Saudi deal had elapsed (at its 50th anniversary) with potentially earth-shattering consequences.  We said we'd take a look.

The 'deal' (as reported) was that the US would guarantee Saudi's security militarily in various ways, in return for the Kingdom only selling its oil in dollars, and reinvesting (most of?) those dollars in US government bonds.  This had the effect of propping up the dollar all these years, as nations globally were forced to buy dollars.  End the deal, end the dollar, was the implication.

Hmm.  Well, firstly I know nothing about macro-economics, so I'm always open to being corrected on some of these things.  (My state of macro ignorance has never held me back, since happily I've always found that micro competence is the way to make money.)

That said, here are a few thoughts.

• several well-informed commentators stated there never was such a deal !
• whether or not the doomsayers knew this (I thought everyone did, but maybe not), the US is about to sign a significant new defence pact with Saudi.**     We probably won't be given the full text ... but I can't imagine the US isn't getting more or less whatever it wants from this
• given that the whole world (not least, China) holds US Treasuries, who wants to crash the dollar anyway?
• the FX markets are just about the most liquid on the planet.  What difference does 'pricing in dollars' make?  (There's my macro ignorance showing - but seriously now, just tell us.  It isn't as if oil is priced in dollars at a fixed price, is it?)
• after many years as a net oil importer (indeed, net energy), since the shale revolution the US has been a net exporter.  That makes the world a rather different place to what it was 50, 30, 20 years ago, in ways that I'm sure the US Treasury is on top of
  

From time to time we hear guff about how China wants the whole world to switch to renminbi, or alternatively some devious crypto-currency of their devising.  Nothing much seems to happen.  Similarly Russia says that, Uncle Sam being a busted flush, it will now export its oil and gas in rubles, thank you very much.  The rest of the world waves them a cheery two fingers.  

The simple fact is that liquidity is liquidity.  Loads of countries announce from time to time that they are going to supplant this or that feature of the established (western-led) global order, but it rarely does them any good.  For many years the Russians have sought to develop a global market in "Urals Blend" crude oil in order to break the tyranny of Brent (i.e. UK / North Sea) pricing, but Brent it remains on the world market.  After Brexit, the EU toyed with the idea of relegating English to "just the language spoken by Malta": and the French fancied their hour had come!  Tough titty, frogs: English it remains, long after the English themselves have departed.  Liquidity is liquidity.

I have a very strong suspicion nothing much has changed between the US and Saudi this year.  At any event, the US dollar remains my hedge against a UK meltdown.  It served me very well during the financial crisis 2007-10.

Any views from those with a proper PPE degree?  

ND

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** Incidentally, within the USA itself there is a significant school of criticism of this deal, not least in military circles: "we don't need their oil, so why do we need them any more?"  Not too difficult to come up with answers to that question, though.

Euro-dollar parity!

There's a thing, eh?

You'll see it described as "pound collapses" - but against the EUR, Sterling is where it was back in 2013, and higher than has been across most of 2017-2021.  OK, not as high as the blip in 2015, but still ... "despite Brexit" ... 

Nope: this is about the USD.  Always the safe haven.  Never underestimate ... etc etc.

OK - now back to all your favourite Ukraine themes. 

ND

Shorting Germany?

Anon, BTL previous post - "any investment suggestions?" ... 

Well we can't and don't do financial advice or recommendations on this blog, so DYODD etc.

But here's something from Capx which is a clear enough recommendation from somebody else: buy dollars and Italy, sell Germany! 

Blast from the past: 2010

The rationale is basically that the Germans are about to cop the bill for the Mediterranean economies.  Hmmm - that's a bit like nuclear fusion, people have been predicting it for a long time.  But maybe now's the hour.  You can also chuck into the pot Germany at long last being called out / caught out as being the mainstay of the Russian economy (both as importer of stuff and exporter of tech), which may not be allowed to last much longer.  What other game do they have to play that could be equally lucrative?  Well, China, of course as regards the tech exports - but the USA won't let 'em have a free run at that, even if they've (the Germans) been surreptitiously sleeving, not to say laundering for Russia these 8 years.

Personally I went 'buy USD' when the whole current thing kicked off which I date to Feb 2021 (when I first reported far-east gas prices going through the roof here) - a general rule of mine over the decades.  He who underestimates the latent strength of the USA is often doomed to a big disappointment.  Saved me in the late '00's when I shorted GBP @ 2.10 in '07 (hat-tip CU, I might add: I can even tell you which pub we were in).  We tracked its glidepath down on the blog, all through the financial crisis.

Gold hasn't been quite as effective this time around.

How much further down can £ go?  Well 1.05 (1982) is the all-time low (That's what it says when I looked it up just now.  From memory, it actually went a bit lower that year).  The psychological floor represented by 1.00 is apparently quite sturdy.  That's not a prediction, by the way.

ND

How Long the Dollar as World Currency?

BTL in a recent post, Anon asked for views on how much of the present ME unpleasantness is explained by US desire to maintain the dollar as the currency in which the world buys oil?   Anon went on to mention that Gaddafi head been mooting a barter scheme to circumvent dealing in dollars before his demise.

This is quite a long post so I'll summarise here: not really plausible, IMHO. 

It's not an academic response, nor does it contain any quantified macro-economics (my being in neither profession): but after a career in pragmatic multinational micro-economics - the energy business - I do have a number of practical observations.

*   *   *   *   *   *

1.  Liquidity / critical mass is vital in every sector.  Nothing stymies business worse than non-fungibility and non-convertability.   Needless to say, if anything that has "currency" today is doing a halfway satisfactory job in the market, that militates strongly against the adoption of anything else.  The intertia / barriers to entry & exit are great.

2.  There have long been plenty of national-pride-based attempts to drag the commercial world away from Anglo-US dominance of the instruments of liquidity.  In my own sphere: many countries hate having their oil priced against Brent (which almost all crude oil is, except US production), let alone in dollars; and there have been attempts to establish marker-prices for other blends, and to have them traded in other financial centres.  Kuwait Blend; Urals Blend, Dubai ... they come along, they get reduced to a basis-differential against Brent, and the world carries on.  And this despite apparently formidable technical difficulties in maintaining "Brent" as a marker (due to terminally declining North Sea production).  But the clever chaps in London cunningly keep extending the definition of the blend and - thus far - they've had total success.

Likewise, and to Anon's question, lots of folks have dreamed of having oil - even just their own local production grades - priced in their own currencies.  You might justly argue that provided there is full FX convertability between those currencies and USD, what's to stop them?  Answer: nothing - except it would be entirely empty.  The whole business world speaks English (and reads the FT), not Russian or Mandarin.  Arbitrage ensures "their" price would always be (Brent USD +/- basis)*FX.

As regards barter schemes ... well, money was invented, partly because there are distinct, nay fatal limitations as to what barter can achieve.  So I don't think Gaddafi represented any kind of threat to dollar oil trade.   BTW, the Russians have tried to sell gas to China in complex packages with industrial equipment - but the Chinese are having none of it!  Cash on the nail, so far as they are concerned.

3.  Some things do change & evolve: but typically only for very good reasons (which do not include national pride).  Example: the first natural gas trading hub in Europe was the UK's "NBP", and European gas prices for many years were given as NBP (+/- basis).  How logical was this, when the UK isn't remotely the centre of gravity of European gas movements, and the Eu deals mostly in EUR?  Very logical indeed - when only the UK's gas market was truly liquid.  However, over time, unsurprisingly several other hubs emerged as the rest of the EU belatedly caught up on gas trading (well, sort-of), one of which - the Dutch TTF -  was very much closer to the continental centre of gravity than our peripheral island market.  A German hub would have been just as likely a candidate: but the Germans genuinely don't understand how markets work, and screwed up their market design.  The Dutch are much better at it: and so today the TTF is more usually given as reference point for "the gas price in Europe".  (By the way, NBP and TTF trade at incredibly high correlations and the basis differential is always easily rationalised - as you'd expect, because they are both liquid, and generally inter-connected physically.)

4.  So: given that things can change over time and with good fundamental reasons, who's to rule out everything coming under Chinese hegemony in the long run, when their economy becomes dominant?  Well, in the very long run, maybe.  But right now they don't really understand markets either, nor indeed quite How The World Works.  Case in point: they'd spent years cultivating Gaddafi (for his oil), and were gobsmacked when "the West" just did away with him one day.   WTF?, you could hear them saying.   And, to their disgust, right now large & mainstream Chinese firms are obliged to, errrr, kowtow to US sanctions on Iran, much as they'd like to exploit the situation commercially. 

Of course, they hate this stuff and have every intention of supplanting it.  One day.  And who knows, maybe Trump will so overplay his hand, he'll help them accelerate the process.

Then again, the French have long hated the use of the English language everywhere - and most specifically in the organs and councils of the EU.  Tough titty, mes braves; not even Brexit is going to change that. 

No lengthy post is complete without an army anecdote.  All army vehicles come with a comprehensive toolkit.  But as I quickly discovered when becoming responsible for a troop of 30 vehicles, there's only one item out of a dozen or so that's ever taken out of the box, and which is permanently going missing - the Spanner Adjustable.  

Yes: some things turn out to be Really Useful.  The English language, the Brent oil contract, and the Almighty USD are excellent examples.  The clever Chinese will need to come up with something even better if they want any of them to be superceded.

ND

Dollar, Donetsk and US Dominance: Ending Any Time Soon?

"The dollar's 70-year dominance is coming to an end", writes Liam Halligan in the Telegraph.  "Within a decade, greenbacks could be replaced as the world's reserve currency."

He isn't the first to predict this, and it seems to be received wisdom in some quarters.  BRIC Development Bank plans are cited in aid by Halligan, along with stats on growing BRIC GDPs, and speculation over what currency (or currencies) the big Russia-China gas deal is denominated in.

Well, people have been announcing the end of oil priced in dollars for a long time, and it really hasn't happened.  The banking crisis seems to have reinforced the dollar's standing.  Given the haste with which the Russians came to the signing-table on the gas deal (reflecting their Ukraine-based desperation to show Europe we aren't needed), the chances that they came up with a fancy new currency arrangement are rather small.

In the long run, I have no doubt China will be up there vying for the Top Nation accolade, but as often argued hereabouts their hesitancy and false-footing in foreign affairs doesn't make them likely to achieve this any time soon.  Timing is everything and "within a decade" for the end of the dollar as world reserve currency looks wildly premature.

I'd go further.  The fact of China as putative Top Nation doesn't really map one-for-one onto currency at all, any more than we'll all soon be speaking Mandarin.  'Currency' means a lot more than 'politico-economic muscle', as the Euro-bloc is painfully finding out.  A complex alignment of reliable legal system, flexibility & pragmatism of authorities, understanding of markets, ease of access, liquidity, adapatability & readiness to embrace change, lack of doctrinaire stubbornness and other factors is required - a combination not readily associated with, errr, China.   Or indeed France, another country that has perennially tried - well, perenially hoped - to be some sort of global player.  The City of London's dominance of the financial world has long outlasted the British Empire.

Changing the subject, but bringing it around to a similar conclusion, the Ukraine situation has obviously taken a very nasty turn while I was on hol.  To chuck in my 2 bits-worth: as Raedwald has suggested, it's rather probable the Americans knew what SAM kit was available to the separatists.  He asked - who did they tell ?  which is one way of looking at it.   I'd guess the USA has an absolutely top-notch vantage-point on everything in the region (just as we do in Cyprus for the Eastern Med) and could tell chapter-and-verse down to the very smallest detail.  It probably won't, though, for the time-honoured reason of not showing its hand.

Yes, it's the USA and its dollar for a while to come.

ND

Return of the Pound; Get your summer holiday money now!

The UK Pound Sterling, long-suffering under the control of Mr. A Darling and Mr. M. King, has staged something of a rally these past few weeks.

Not long ago sinking below parity with the Euro was the talk of the town and reaching parity with the US Dollar. But like a phoenix from the flames, the pound has reached nearly 1.15 to the Euro and the US Dollar rate is a mighty 1.64 today.

Behind the rises are a big move in closing short positions on the Pound and also a flight away from the dollar into more risky assets. As such demand for dollars goes down and so the currency falls.

However, there is no sign as to whether this is a longer-term trend coming into play. More likely, this currency reversal will itself reverse when the equity markets end their rally in the next couple of months.

As such, if you are planning a trip abroad over the summer, think carefully about when you buy your currency. Now may be a good time if you can afford to put the money aside. Alternatively, watch the global markets, if there is a strong downturn the currencies will follow quickly, so don't dither.