Posts Tagged ‘Yuan’

 

Will the rise of China mean the fall of America? In a word, yes. Although decline might be more accurate.

Why do I think this? Because China is about to launch the PetroYuan and when it does the demand for dollars and for dollar denominated debt will shrink. When it does, I question whether the world will be so sanguine about the level of debt that America carries. If that happens then the value of the dollar is in question.

At the moment no matter what level of debt America carries, other countries need dollars. Dollars to pay for oil, since oil is traded in dollars. Dollars for their financial system so their banks can settle contracts for goods and services traded in dollars.

But over the last few years China has been systematically putting in place everything it needs to launch the Yuan as not only a rival to the dollar in trading and settling oil contracts but as a rival to the dollar as the world’s reserve currency. At the moment the only rival to the dollar is the Euro. I think it fair to say the relationship between the two currencies and their issuing powers, has been… ‘delicate’. The news that Sadam Hussein was going to start trading his oil in Euros came just a few months before America and its lap dog GB, decided Sadam was a threat to world peace and went to war with him. Something similar happened to Colonel Qaddafi.

Under Qaddafi Libya’s currency was backed by the country’s large holdings of gold and silver. This had allowed Qaddafi to finance, for example, the entire construction of the Great Man Made River without going to Western banks for a single loan. Libya was debt free and owned its own resources and infrastructure. Obviously a very unsatisfactory state of affairs for any third world country to get ideas so far above their station. Worse, he had a very public plan which he had laid before the Pan African Congress, to create a pan African currency backed by gold and silver to be launched by 2023. It was not too long before Hilary Clinton arrived in a freshly bombed Libya and crowed to CBS, “We came, we saw, he died.” Charming woman. I was only surprised she didn’t say “Mission accomplished.”

Libya and Iraq were small enough, that their pretensions to threaten the hegemony of the dollar and have the jumped up arrogance to think they could trade their own resources in their own currency or a currency of their choice, could be dealt with by shock, awe and death. I think China might not be so easily dealt with.

China’s plans for the replacement of the dollar and the positioning of their own currency are very like Libya’s. China too has had the idea to back its new settlement and perhaps one day its reserve currency, with gold. And China is not alone. Russia has been a part of the BRIC group with an interest in the plan. Russia, like China has been a very large buyer of gold.

 

As reported just a few weeks ago by the Irish Independent,

…the Bank of Russia has more than doubled the pace of gold purchases, bringing the share of bullion in its international reserves to the highest of Mr Putin’s 17 years in power, according to World Gold Council data.

In the second quarter alone, it accounted for 38pc of all gold purchased by central banks.

The article goes on to explain how purchasing gold has meant that Russia has not had to buy foreign currencies. For foreign currencies think Dollars.

The gold rush is allowing the Bank of Russia to continue growing its reserves while abstaining from purchases of foreign currency for more than two years.

China and Russia have very large holdings of gold between them. China actually produces 12% of the world’s gold and keeps much if not most of what it produces. The new Petro Yuan will be backed by Gold, Something the IMF decades ago, said no paper currency should have. A clear break with the Bretton Woods Dollar-world agreement.

Who will use this new currency? Over the past few years a network of bilateral agreements has been created around China and Russia. Back in 2012, in an article called A new Reserve currency to challenge the dollar – What’s really going on in The Straits of Hormuz, I pointed out that not only had China and Russia agreed to bypass the dollar and trade direct in their own currencies but that,

the India Times reported that India was talking to Iran about moving out of dollar settlements so as to be able to buy Iranian oil despite a US embargo. India said it was discussing settling in Gold. Remember, India has just signed a settlement agreement with China to use the Yuan.

Remember also, Russia recently eclipsed Saudi as the number one supplier of China’s oil. And if I remember correctly Angola was number two. Promoting perhaps the recent state visit this year of Saudi’s King Salman to see Mr Putin. As The Guardian put it,

 

Saudi king’s visit to Russia heralds shift in global power structure

King Salman agrees new areas of cooperation with Vladimir Putin on first official trip by Saudi monarch to Moscow

In addition Japan and China have agreed to trade in Yuan, by-passing the dollar, as has Iran. They are now trading their oil in Yuan or euros, but not the dollar. Ever wondered why Iran is ‘the axis of evil? It’s because they don’t use the dollar.

Then came the news in 2015 that Qatar had opened the first and so far only financial centre in the Middle East, for trading and clearing oil, gas and anything else, in Yuan. China’s ICBC is the central banking concern in the hub, allowing any Middle Eastern country to trade oil and gas and settle in Yuan. In the previous few years China’s trade with Qatar had tripled. And now, guess what? Qatar has been declared by the US to be a sponsor of terrorism and US allies in the gulf , led by Saudi, have begun to blockade Qatar’s trade. Hmm. Any pattern emerging?

The problem for the US is how much debt is too much for any country or business? Clearly it is not any magic figure or particular debt to GDP ratio. America and China carry huge debts and no one has balked…yet. How much debt you can carry is a function of debt to the estimated future productive capacity of the country in question. That creates the demand for its currency and the demand for the currency creates a market and demand for debt denominated in that currency.

At the moment the US can carry a huge debt load because everyone needs dollars to trade oil. And China can carry a huge debt because everyone needs yuan to buy the goods whose production was off-shored to China by our globalist leadership.

But what happens to demand for Dollars and dollar debt when, not if, oil starts to be traded less and less in dollars? I suggest the world’s appetite will diminish quite quickly. As it does so, the world will start to see US debt in a different light. While the opposite will happen to China. And this is what interests me and makes me think China has a plan.

At the moment China also has a very large debt load. I have argued that the Central Chinese authorities have not got the control they would like to have over the growth of that debt. Of course I have no inside information. But the on again/ off again attempts of the Chinese central authorities to deflate its housing-debt bubble and its quite out-of-control shadow banking lending suggests, to me at least, that the central authorities have not and can not control the level of debt being accumulated by provincial governments, their off-book, arm’s length financial vehicles, regional banks, property developers and the vast, largely unregulated trade in wealth management vehicles.

Chinese debt already overflowed once back in the 90’s. Four companies were created to take the debt off the banks’ books and trade it away. Decades later these companies still exist and still have the bad debts from the 90’s hanging around. You will see headlines telling you how those companies have been doing well, making money. Suggesting their trade in bad chinese debt has been going well. The reality, if you dig a little deeper, is that those companies lobbied for and were given permission to engage in ‘proper’ banking activities. Which meant they began to make their own loans – to property developers. As the property bubble continued to inflate over the last decade and a half they have ridden it and that, not trading the old bad-debt, is why they have made a profit. But now those ‘bad’ banks, have themselves started to find some of their own loans going bad. In any hard-landing or financial paroxysm the ‘bad-banks’ will need to be rescued by a new bad banks. Bad banks for bad banks is not really a solution.

I think the Chinese authorities can see this. It doesn’t take a genius after all. What can they do? Well if you already have a huge debt problem and know many of them are going to go bad and will do so overnight in the event of another global banking crisis, and know you are not able to reign it all in, then a very tempting alternative would be to get the world to agree that you can carry more debt – a lot more. And what could help convince the world? Well if your currency could become far more sought after, that would be peachy.

And so I think the long standing Chinese goal of making the yuan

an important international currency which China, and Hong Kong in particular, have been working towards for years, has now taken on a far greater import and urgency. I think the Chinese central government’s best way of avoiding a politically disastrous domestic debt implosion is to get the Yuan to be used as a settlement currency for oil and not long after that to become a de facto rival to the dollar as the world’s reserve currency.

Recently I argued at length with a military analyst who disagreed that China would risk such a break with America. Too dangerous he felt. China, he pointed out has such huge holdings of American debt. He argued that the Chinese would prefer to work alongside the dollar. I feel that even if the Chinese would prefer to ‘work alongside’ the dollar, this will prove very difficult if not impossible. Once a flow of countries and trade moves away from the dollar there will be a momentum the Chinese will not be in control of. Cooperation between dollar and Yuan as clearing and reserve currency, especially for oil, will be like trying to dock two super-tankers in a high sea. In theory possible. In practice – not going to work.

As for Chinese holdings of US debt – I think the advantages of avoiding a domestic debt implosion and projecting the Yuan to world centre stage, will outweigh the losses. I also think, If I were the Chinese, I would imagine a scenario where the dollar does begin to look vulnerable. Its value begins to be questioned, nations holding dollars and dollar debt will feel America’s profligate indebtedness is a global danger. They will blame America. How wonderful then, for China to arrive and say to a worried world, on the edge of a huge crisis, “Fear not, we have thought ahead and can offer you the use of a new currency – one backed by GOLD not paper debts. We are here to save you. To offer a ride on a sound ship as an alternative to the rotten and leaking ship you have been riding on.” China will be able to position their rise not as an aggressive act, not as trying to destabilise the world, but as trying to save it, from the collapse of an internally divided, corrupt, aggressive and indebted America.

America’s decline will be both financial and political. Financial due to the recalibration of what the world thinks of America’s debt load, and therefore their confidence in and need for the dollar. Political, because America

has got used to being able to enforce its foreign policy through sanctions and embargoes. But once oil and other goods and the nations trading in them, no longer need the dollar for their trade, and do not have to use US clearing or custodial banks, then this power evaporates.

Try to imagine the shift in power when Wall Street’s banks are no longer guaranteed top position as the world’s custodial banks and Manhattan’s Southern District Court (Wall Street’s court) is no longer in a position to dictate to whole nations via decisions upon Wall Street Custodial banks, what debts those nations and their custodial banks must pay and to whom. The whole edifice of Bilateral Investment Treaties and the trade agreements they sit inside, depends for enforcement upon the US banks being the custodial banks and the Southern District court’s rulings being able to tell those banks what they must do. Take that power away, which will happen if the dollar is no longer pre-emininent, and America will no longer be able to enforce its foreign policy or world view via economic sanction.

I think the main US banks will be positioning themselves to try to bridge this decline by having a major presence in Hong Kong. They are all already there but will be working to be part of the new Yuan-world of trade and clearing.

Of course this is speculation. But it seems to me the underlying evidence of the previous decade makes it worth thinking about.

If I am in any way correct then I think other things follow.

I think the House of Saud knows it’s future is in question. I have written a lot about how I see Qatar rising to rival Saudi. Qatar not Saudi has the Yuan clearing house. Saudi is late to the party. Can Saudi risk being seen to move away from its

traditional ally, America? If it does, too quickly, and signs yuan trade deals it risks falling as soon as Americal turns its back. If it doesn’t move quickly enough it risks being completely eclipsed by Qatar, having to go to Qatar cap in hand to trade its oil with Russia and China.

I see the political changes within the House of Saud as signs of the internal struggles to decide which way to go. I personally think the House of Saud will fall.

I also think the position of Israel under its present leadership is also very fragile. Israel needs Saudi. While they may seem to be on opposite sides, in many ways they are on the same side. If the House of Saud falls or changes allegiances from America to Russia/China then Israel will become even more isolated than it is. And of course if America is eclipsed and does enter a period of decline, then Israel will go with it.

If any of the above is near the mark, will it mean the end of America? Of course not. American’s will still work and sleep and raise their children like everyone else. But the pre-eminence of the dollar and American finance will decline as the stock of dollar denominated bonds and debt agreements expires, and with it the power and wealth of many of America’s elite. How that decline will sit alongside America’s still overwhelming military power I don’t know.

Of course what I have suggested above is merely speculation but personally I think another debt crisis will happen, because never ending QE and Central Bank debt buying cannot go one for ever, and what China does in the next few months could very well destabilise the whole unstable system. Many people will suffer and lives will be blighted. But I wonder if, when we all look back from a decade or a generation after, if we won’t think it lucky the crisis did finally come and the system we have been slaving under since 2007 as well as those who have forced it upon us for their own enrichment, were called to account.

It is difficult to accept that such historic changes could occur. But history has not ended despite what some have claimed.

Rumours of History’s end have been, in my opinion, greatly exaggerated. History is very much alive and happening to us, now. We are, as the Chinese saying goes, living in interesting times.

 

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The petrodollar system is being undermined by exponential growth in technology and shifting geopolitics. What comes next is a paradigm shift…

 

In the summer of 1974, Treasury Secretary William Simon traveled to Saudi Arabia and secretly struck a momentous deal with the kingdom. The U.S. agreed to purchase oil from Saudi Arabia, provide weapons, and in essence guarantee the preservation of Saudi oil wells, the monarchy, and the sovereignty of the kingdom. In return, the kingdom agreed to invest the dollar proceeds of its oil sales in U.S. Treasuries, basically financing America’s future federal expenditures.

Soon, other members of the Organization of Petroleum Exporting Countries followed suit, and the U.S. dollar became the standard by which oil was to be traded internationally. For Saudi Arabia, the deal made perfect sense, not only by protecting the regime but also by providing a safe, liquid market in which to invest its enormous oil-sale proceeds, known as petrodollars. The U.S. benefited, as well, by neutralizing oil as an economic weapon. The agreement enabled the U.S. to print dollars with little adverse effect on interest rates, thereby facilitating consistent U.S. economic growth over the subsequent decades.

An important consequence was that oil-importing nations would be required to hold large amounts of U.S. dollars in reserve in order to purchase oil, underpinning dollar demand. This essentially guaranteed a strong dollar and low U.S. interest rates for a generation.

[ZH: Still, the underlying concept of how Petrodollar recycling, or as some call it, petrocurrency mercantilism works, leaves some confusion. So in order to alleviate that, here courtesy of Cult State, is a quick and simple primer that should hopefully answer all questions. From CultState:

So what is petrocurrency mercantilism?

It’s when a national bank and an energy producer collude to generate artificial demand for a currency at the expense of the purchasing power of other currencies.

The flowchart below shows how it all works.

Given this backdrop, one can better understand many subsequent U.S. foreign-policy moves involving the Middle East and other oil-producing regions.

Recent developments in technology and geopolitics, however, have already ignited a process to bring an end to the financial system predicated on petrodollars, which will have a profound impact on global financial markets. The 40-year equilibrium of this system is being dismantled by the exponential growth of technology, which will have a bearish impact on both supply and demand of petroleum. Moreover, the system no longer is in the best interest of key participants in the global oil trade. These developments have begun to exert influence on financial markets and will only grow over time. The upheaval of the petrodollar recycling system will trigger a resurgence of volatility and new price trends, which will lead to a renaissance in macro investing.

Let’s examine these developments in more detail.

First, TECHNOLOGY is affecting the energy markets dramatically, and this impact is growing exponentially. The pattern-seeking human mind is built for an observable linear universe, but has cognitive difficulty recognizing and understanding the impact of exponential growth.

Paralleling Moore’s Law, the current growth rate of new technologies roughly doubles every two years. In the transportation sector, the global penetration rate of electric vehicles, or EVs, was 1% at the end of 2016 and is now probably about 1.5%. However, a doubling every two years of this level of usage should lead to an automobile market that primarily consists of EVs in approximately 12 years, reducing gasoline demand and international oil revenue to a degree that today would seem unfathomable to the linear-thinking mind. Yes, the world is changing—rapidly.

Alternative energy sources (solar power, wind, and such) also are well into their exponential growth curves, and are even ahead of EVs in this regard. Based on growth curves of other recent technologies, and due to similar growth rates in battery technology and pricing, it is likely that solar power will supplant petroleum in a vast portion of nontransportation sectors in about a decade. Albert Einstein is rumored to have described compound interest (another form of exponential growth) as the most powerful force in the universe. This is real change.

The growth of U.S. oil production due to new technologies such as hydraulic fracturing and horizontal drilling has both reduced the U.S. need for foreign sources of oil and led to lower global oil prices. With the U.S. economy more self-reliant for its oil consumption, reduced purchases of foreign oil have led to a drop in the revenues of oil-producing nations and by extension, lower international demand for Treasuries and U.S. dollars.

China has agreed with Russia to purchase Russian oil and natural gas in yuan.
◦As an example of China’s newfound power to influence oil exporters, China has persuaded Angola (the world’s second-largest oil exporter to China) to accept the yuan as legal tender, evidence of efforts made by Beijing to speed up internationalization of the yuan. The incredible growth rates of the Chinese economy and its thirst for oil have endowed it with tremendous negotiating strength that has led, and will lead, other countries to cater to China’s needs at the expense of their historical client, the U.S.
◦China is set to launch an oil exchange by the end of the year that is to be settled in yuan. Note that in conjunction with the existing Shanghai Gold Exchange, also denominated in yuan, any country will now be able to trade and hedge oil, circumventing U.S. dollar transactions, with the flexibility to take payment in yuan or gold, or exchange gold into any global currency.
◦As China further forges relationships through its One Belt, One Road initiative, it will surely pull other exporters into its orbit to secure a reliable flow of supplies from multiple sources, while pressuring the terms of the trade to exclude the U.S. dollar.

The world’s second-largest oil exporter, Russia, is currently under sanctions imposed by the U.S. and European Union, and has made clear moves toward circumventing the dollar in oil and international trade. In addition to agreeing to sell oil and natural gas to China in exchange for yuan, Russia recently announced that all financial transactions conducted in Russian seaports will now be made in rubles, replacing dollars, according to Russian state news outlet RT. Clearly, there is a concerted effort from the East to reset the economic world order.

ALL OF THESE DEVELOPMENTS leave global financial markets vulnerable to a paradigm shift that has recently begun. In meetings with fund managers, asset allocators, and analysts, I have found a virtually universal view that macro investing—investing based on global macroeconomic and political, not security-specific trends—is dead, fueled by investor money exiting the space due to poor returns and historically high fees in relation to performance. This is what traders refer to as capitulation. It occurs when most market participants can’t take advantage of a promising opportunity due to losses, lack of dry powder, or a psychological inability to proceed because of recency bias.

A current generational low in volatility across a wide spectrum of asset classes is another indicator that the market doesn’t see a paradigm shift coming. This suggests that current volatility is expressing a full discounting of stale fundamental inputs and not adequately pricing in the potential of likely disruptive events.

THE FEDERAL RESERVE is now in the beginning stages of a shift toward “normalization,” which will lead to diminished support for the U.S. Treasury market. The Fed’s total assets stand at approximately $4.5 trillion, or five times what they were prior to the financial crisis of 2008-09. The goal of the Fed is to “unwind” this enormous balance sheet with minimal market disruption. This is a high-wire act a thousand feet in the air without a safety net or prior practice. Additionally, at some not-so-distant future date, the U.S. will need to finance enormous and growing entitlement programs, and our historical international sources for that financing will no longer be willing to support us in that endeavor.

The market participants with whom I met theoretically could have the ability to accept cognitively the points made in this article. But the accumulation of many small losses in a low-volatility and generally trendless market has robbed them of confidence and the psychological balance to embrace any new paradigm proactively. They are frozen with fear that the lower- return profile of recent years is permanent—ironic in an industry that is paid to capture price changes in a cyclical world.

One market legend with whom I spoke suggested he wouldn’t have had the success he enjoyed in his career had he begun in the past decade. Whether or not this might be true, it doesn’t mean that recent lower returns are to be extrapolated into the future, especially when these subpar returns occurred during the quantitative-easing era, a period that is an anomaly.

I have been fortunate to ride substantial bets on big trends, earning high risk-adjusted returns using time-tested techniques for exploiting these trends. Additionally, I have had the luxury of not participating actively full-time in macro investing during this difficult period. Both factors might give me perspective. I regard this as an extraordinarily opportune moment for those able to shed timeworn, archaic assumptions of market behavior and boldly return to the roots of macro investing.

The opportunity is reminiscent of the story told by Stanley Druckenmiller, who was promoted early in his investment career to head equity research at a time when his co-workers had vastly more experience than he did. His director of investments informed him that his promotion owed to the same reason they send 18-year-olds to war; they are too dumb to know not to charge. The “winners” under the paradigm now unfolding will be market participants able to disregard stale, anomalous concepts, and charge.

RELATEDLY, THERE IS a running debate as to whether trend-following is a dying strategy. There is plenty of anecdotal evidence that short-term and mean-reversion trading is more in vogue in today’s markets (think quant funds and “prop” shops). Additionally, the popularity of passive investing signals an unwillingness to invest in “idea generation,” or alpha. These developments represent a full capitulation of trend following and macro trading.

Ironically, many market players who wrongly anticipated a turn in recent years to a more positive environment for macro and trend-following are throwing in the towel. The key difference is that now there is a clear catalyst to trigger the start of the pendulum swinging back to a fertile macro/trend-following trading environment.

As my mentor, Bruce Kovner [the founder of Caxton Associates] used to say, “Nobody rings a bell at key turning points.” The ability to properly anticipate change is predicated upon detached analysis of fundamental information, applying that information to imagine a plausible world different from today’s, understanding how new data points fit (or don’t fit) into that world, and adjusting accordingly. Ideally, this process leads to an “aha!” moment, and the idea crystallizes into a clear vision. The thesis proposed here is one such vision.

Authored by James Rickards

 

China is a relatively open economy; therefore it is subject to the impossible trinity.

China has also been attempting to do the impossible in recent years with predictable results.

Beginning in 2008 China pegged its exchange rate to the U.S. dollar. China also had an open capital account to allow the free exchange of yuan for dollars, and China preferred an independent monetary policy.

The problem is that the Impossible Trinity says you can’t have all three. This model has been validated several times since 2008 as China has stumbled through a series of currency and monetary reversals.

For example, China’s attempted the impossible beginning in 2008 with a peg to the dollar around 6.80. This ended abruptly in June 2010 when China broke the currency peg and allowed it to rise from 6.82 to 6.05 by January 2014 — a 10% appreciation.

This exchange rate revaluation was partly in response to bitter complaints by U.S. Treasury Secretary Geithner about China’s “currency manipulation” through an artificially low peg to the dollar in the 2008 – 2010 period.

After 2013, China reversed course and pursued a steady devaluation of the yuan from 6.05 in January 2014 to 6.95 by December 2016. At the end of 2016, the Chinese yuan was back where it was when the U.S. was screaming “currency manipulation.”

Only now there was a new figure to point the finger at China. The new American critic was no longer the quiet Tim Geithner, but the bombastic Donald Trump.

Trump had threatened to label China a currency manipulator throughout his campaign from June 2015 to Election Day on November 8, 2016. Once Trump was elected, China engaged in a policy of currency war appeasement.

China actually propped up its currency with a soft peg. The trading range was especially tight in the first half of 2017, right around 6.85.

In contrast to the 2008 – 2010 peg, China avoided the impossible trinity this time by partially closing the capital account and by raising rates alongside the Fed, thereby abandoning its independent monetary policy.

This was also in contrast to China’s behavior when it first faced the failure of its efforts to beat impossible trinity. In 2015, China dodged the impossible trinity not by closing the capital account, but by breaking the currency peg.

In August 2015, China engineered a sudden shock devaluation of the yuan. The dollar gained 3% against the yuan in two days as China devalued.

The results were disastrous.

U.S. stocks fell 11% in a few weeks. There was a real threat of global financial contagion and a full-blown liquidity crisis. A crisis was averted by Fed jawboning, and a decision to put off the “liftoff” in U.S. interest rates from September 2015 to the following December.

China conducted another devaluation from November to December 2015. This time China did not execute a sneak attack, but did the devaluation in baby steps. This was stealth devaluation.

The results were just as disastrous as the prior August. U.S. stocks fell 11% from January 1, 2016 to February 10. 2016. Again, a greater crisis was averted only by a Fed decision to delay planned U.S. interest rate hikes in March and June 2016.

The impact these two prior devaluations had on the exchange rate is shown in the chart below.

Major moves in the dollar/yuan cross exchange rate (USD/CNY) have had powerful impacts on global markets. The August 2015 surprise yuan devaluation sent U.S. stocks reeling. Another slower devaluation did the same in early 2016. A stronger yuan in 2017 coincided with the Trump stock rally. A new devaluation is now underway and U.S. stocks may suffer again.

 

China cannot keep the capital account closed without damaging badly needed capital inflows. Who will invest in China if you can’t get your money out?

China also cannot maintain high interest rates because the interest costs will bankrupt insolvent state owned enterprises and lead to an increase in unemployment, which is socially destabilizing.

China cannot maintain a strong yuan because that damages exports, hurts export-related jobs, and causes deflation to be imported through lower import prices. An artificially inflated currency also drains the foreign exchange reserves needed to maintain the peg.

Since the impossible trinity really is impossible in the long-run, and since China’s current solutions are non-sustainable, what can China do to solve its policy trilemma?

The most obvious course, and the one likely to be implemented, is a maxi-devaluation of the yuan to around the 7.95 level or lower.

This would stop capital outflows because those outflows are driven by devaluation fears. Once the devaluation happens, there is no longer any urgency about getting money out of China. In fact, new money should start to flow in to take advantage of much lower local currency prices.

There are early signs that this policy of devaluation is already being put into place. The yuan has dropped sharply in the past month from 6.45 to 6.62. This resembles the stealth devaluation of late 2015, but is somewhat more aggressive.

The geopolitical situation is also ripe for a Chinese devaluation policy. Once the National Party Congress is over in late October, President Xi will have secured his political ambitions and will no longer find it necessary to avoid rocking the boat.

 

China’s President Xi Jinping awaits appointment to a second term at the 19th National Congress of the Communist Party of China, starting October 18. His reappointment is a foregone conclusion.

China has clearly failed to have much impact on North Korea’s nuclear weapons ambitions. As war between North Korea and the U.S. draws closer, neither China nor the U.S. will have as much incentive to cooperate with each other on bilateral trade and currency issues.

Both Trump and Xi are readying a “gloves off” approach to a trade war and renewed currency war. A maxi-devaluation of the yuan is Xi’s most potent weapon.

Finally, China’s internal contradictions are catching up with it. China has to confront an insolvent banking system, a real estate bubble, and a $1 trillion wealth management product Ponzi scheme that is starting to fall apart.

A much weaker yuan would give China some policy space in terms of using its reserves to paper over some of these problems.

Less dramatic devaluations of the yuan led to U.S. stock market crashes. What does a new maxi-devaluation portend for U.S. stocks?

We might have an answer soon enough.

 

Did the doomsday clock on the petrodollar (and implicitly US hegemony) just tick one more minute closer to midnight?

Apparently confirming what President Maduro had warned following the recent US sanctions, The Wall Street Journal reports that Venezuela has officially stopped accepting US Dollars as payment for its crude oil exports.

As we previously noted, Venezuelan President Nicolas Maduro said last Thursday that Venezuela will be looking to “free” itself from the U.S. dollar next week. According to Reuters,

“Venezuela is going to implement a new system of international payments and will create a basket of currencies to free us from the dollar,” Maduro said in a multi-hour address to a new legislative “superbody.” He reportedly did not provide details of this new proposal.

Maduro hinted further that the South American country would look to using the yuan instead, among other currencies.

“If they pursue us with the dollar, we’ll use the Russian ruble, the yuan, yen, the Indian rupee, the euro,” Maduro also said.

And today, as The Wall Street Journal reports, in an effort to circumvent U.S. sanctions, Venezuela is telling oil traders that it will no longer receive or send payments in dollars, people familiar with the new policy said.

 

Oil traders who export Venezuelan crude or import oil products into the country have begun converting their invoices to euros.

The state oil company Petróleos de Venezuela SA, known as PdVSA, has told its private joint venture partners to open accounts in euros and to convert existing cash holdings into Europe’s main currency, said one project partner.

The new payment policy hasn’t been publicly announced, but Vice President Tareck El Aissami, who has been blacklisted by the U.S., said Friday, “To fight against the economic blockade there will be a basket of currencies to liberate us from the dollar.”

There is no major market reaction for now – a modest bid to Bitcoin and some weakness in EUR and Gold (seems someone wants this to look like nothing).

However, as Nomura debt analyst Siobhan Morden warns:

“You can say whatever you want for your domestic propaganda and make it look like you’re retaliating against the U.S…. This political posturing will only be to their detriment.”

So what happens if Europe also sanctions Venezuela? Will Rubles or Yuan… or Gold be the only way to buy Venezuela’s oil?

* * *

This decision by the nation with the world’s largest proven oil reserves comes just days after China and Russia unveiled the latest Oil/Yuan/Gold triad at the latest BRICS conference.

It’s when President Putin starts talking that the BRICS reveal their true bombshell. Geopolitically and geo-economically, Putin’s emphasis is on a “fair multipolar world”, and “against protectionism and new barriers in global trade.” The message is straight to the point.

“Russia shares the BRICS countries’ concerns over the unfairness of the global financial and economic architecture, which does not give due regard to the growing weight of the emerging economies. We are ready to work together with our partners to promote international financial regulation reforms and to overcome the excessive domination of the limited number of reserve currencies.”

To overcome the excessive domination of the limited number of reserve currencies” is the politest way of stating what the BRICS have been discussing for years now; how to bypass the US dollar, as well as the petrodollar.

Beijing is ready to step up the game. Soon China will launch a crude oil futures contract priced in yuan and convertible into gold.

This means that Russia – as well as Iran, the other key node of Eurasia integration – may bypass US sanctions by trading energy in their own currencies, or in yuan.

Inbuilt in the move is a true Chinese win-win; the yuan will be fully convertible into gold on both the Shanghai and Hong Kong exchanges.

The new triad of oil, yuan and gold is actually a win-win-win. No problem at all if energy providers prefer to be paid in physical gold instead of yuan. The key message is the US dollar being bypassed.

RC – via the Russian Central Bank and the People’s Bank of China – have been developing ruble-yuan swaps for quite a while now.

Once that moves beyond the BRICS to aspiring “BRICS Plus” members and then all across the Global South, Washington’s reaction is bound to be nuclear (hopefully, not literally).

Washington’s strategic doctrine rules RC should not be allowed by any means to be preponderant along the Eurasian landmass. Yet what the BRICS have in store geo-economically does not concern only Eurasia – but the whole Global South.

Sections of the War Party in Washington bent on instrumentalizing India against China – or against RC – may be in for a rude awakening. As much as the BRICS may be currently facing varied waves of economic turmoil, the daring long-term road map, way beyond the Xiamen Declaration, is very much in place.

* * *

Having threatened China today with exclusion from SWIFT, we suspect Washington is rapidly running out of any great ally to sustain the petrodollar-driven hegemony (and implicitly its war machine). Cue the calls for a Venezuelan invasion in 3…2..1…!

CA.L- How unfortunately hilarious this is…

Philippine President Rodrigo Duterte arrived in China to meet with Chinese Premier Xi Xinping. Duterte has become a very controversial figure in Asian politics as he has publicly excoriated U.S. President Barack Obama’s treatment of him and his country.

Duterte has pursued a frank and brutal policy to clean up drug trafficking and crime in the Philippines while at the same time backing away from U.S. influence over the former U.S. colony.

His meeting with Xinping comes after multiple public clashes with Obama which has led to ending joint sea patrols with the U.S. Seventh Fleet in the disputed South China Sea.

These increased patrols and diplomatic overtures in Southeast Asia, particularly with Vietnam are all part of the ‘Asian Pivot’ of which Hillary Clinton was the architect during her reign as Secretary of State.

That Duterte is looking to mend fences with China after the ruling by the Permanent Court of Arbitration in The Hague, Netherlands back in June which denied China’s historical claims to much of the South China Sea is telling.

Because the Philippines has been the loudest opponent of China’s territorial claims.

Vietnamese Waffling

Across the way, Vietnam, on the other hand, has been vocal and taken steps to make substantive claims in the Paracels, it has also been willing to negotiate with China on this issue.

Tensions in the region are always high given the historical backdrop of past Chinese invasions. Vietnamese political moves, in particular, are largely built based on fear of future Chinese colonization, either de facto or through economic means.

This is why, in particular, Vietnam is willing to green light the reopening of Cold War Era Russian military bases there and invite Russian investment in industries normally closed to significant foreign investment like oil production, including offshore exploration and refining.

Talks between Gazprom Neft and state-owned PetroVietnam broke down over the sale of 49% of the refinery at Dun Quat in January, but the fact that Russia got that far in negotiations for that big a stake is itself significant. Vietnam has been desperate to get Dun Quat sold to expand its capacity for three years now but has been unsuccessful in getting a deal done.

This is likely due to a mix of pressures behind the scenes as the U.S. continues to put pressure on the country to not make ties between it and the emerging Russia/China alliance too strong. And Prime Minister Dung has played his poor hand well to get Vietnam concessions from everyone while remaining, at least nominally, independent.

Don’t be surprised in the near future if Vietnam’s terms on Dung Quat become acceptable to Gazprom Neft if the Russians go through with reopening those bases mentioned above.

Russia is seen as a calming influence on any imperial ambitions of the Chinese by regional actors. It has little to do with Russian territorial imperialism. Vietnam is an important strategic and commercial hub in the region historically and it will be difficult for the U.S.’s pivot there to do anything but delay the inevitable.

Flipping the Philippines

The Philippines understands this as well and Duterte’s breaking with the U.S. leadership publicly hands China a grand opening to firm up support within ASEAN – the Association of Southeast Asian Nations. Ties with Thailand, Myanmar, Malaysia and Singapore are strong thanks to strong trade relations.

Xinping just made a deal with Cambodia to help modernize its military.

Once Obama leaves office, U.S. support for Indonesia will drop off a cliff. His personal ties there have ensured a flood of money into that country. It will now have to make deals without that crutch in its back pocket.

While for China, with its soft-peg to the strengthening U.S. dollar, they have very smartly deepened the market for clearing trade directly in local currencies, bypassing the U.S. dollar and insulating these countries from the worst of a dollar bull market, which is again underway, as I discussed last week.

It is also why China is devaluing the Yuan slowly in order to protect its ASEAN trading partners by keeping its real effective exchange rate from rising further and gutting two-way trade.

None of this is lost on Duterte. The resistance to China’s influence over ASEAN is crumbling as China, smartly, has pivoted a larger portion of its trade towards its regional neighbors. With the depression in Europe and the weakness of the Euro, trade between the regions no longer makes sense.

The Philippines cannot be a hold out against the tide of waning U.S. influence in the region lest all the work he’s done to clean up the corruption and violence – regardless of what you may think of his methods – will come to naught.

His trip to China this week is very bad news for Clinton and Obama and it is very likely that the Asian Pivot policy will unravel in short order.

 

An interesting, but extremely important piece of news fell through the cracks earlier this week, that has the potential to be one of the most powerful attacks on the dollar’s reserve currency status since 1973.  And it appears to be happening using the West’s own mechanism against them.

On Aug. 1, China announced that around the 1st of October they will be internationalizing the IMF’s Special Drawing Right’s (SDR) currency for global use in trade, thus placing the currency basket in play for nations to use instead of the dollar.

“Now in August of 2016, we are very close to the first SDR issuance of the private sector since the 1980s.

Opinion pieces in the media and speculation by informed sources prepared us for the launch of an instrument most people don’t know about earlier in 2016. Then the International Monetary Fund (IMF) itself published a paper discussing the use of private sector SDRs in July, and a Chinese central bank official confirmed an international development organization would soon issue SDR bonds in China, according to Chinese media Caixin.

Caixin now confirmed which organization exactly will issue the bonds and when: The World Bank and the China Development Bank will issue private sector or “M” SDR in August.

The so-called SDR are an IMF construct of actual currencies, right now the euro, yen, dollar, and pound. It made news last year when the Chinese renminbi was also admitted, although it won’t formally be part of the basket until Oct. 1 of this year.

How much? Nikkei Asian Review reports the volume will be between $300 and $800 million and some Japanese banks are interested in taking up a stake. According to Nikkei some other Chinese banks are also planning to issue SDR bonds. One of them could be the Industrial and Commercial Bank of China (ICBC) according to Chinese website Yicai.com.

The IMF experimented with these M-SDRs in the 1970s and 1980s when banks had SDR 5-7 billion in deposits and companies had issued SDR 563 million in bonds. A paltry amount, but the concept worked in practice.

The G20 finance ministers confirmed they will push this issue, despite private sector reluctance to use these instruments. In their communiqué released after their meeting in China on July 24:
“We support examination of the broader use of the SDR, such as broader publication of accounts and statistics in the SDR and the potential issuance of SDR-denominated bonds, as a way to enhance resilience [of the financial system].”

They are following the advice of governor of the People’s Bank of China (PBOC), Zhou Xiaochuan, although a bit late. Already in 2009 he called for nothing less than a new world reserve currency.

“Special consideration should be given to giving the SDR a greater role. The SDR has the features and potential to act as a super-sovereign reserve currency,” wrote Zhou. ”

— Epoch TImes

What is most extraordinary about this is that control over the M SDR will come from Chinese authority, and with the blessings of Japan, Europe, and members of the G20.  And this move will also provide China the initial boost it needs to act as a second caretaker of the global reserve currency system, and bring them one step closer to implementing their end game goal of a gold backed trade program.

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In addition to this move, China will announce the results of a new audit for their gold reserves, which is a key part in the IMF allowing China to become the gatekeeper for SDR internationalization.  And dependent upon how much they declare their reserves to be, it could be a shock to the system for U.S. hegemony over the gold price, and open the door for Shanghai to wrest full control over the pricing of precious metals.

How this will affect the upcoming U.S. elections is unclear, but it is no coincidence that these two events will be occurring in October, and at the time where a change in power for the U.S. empire is taking place.  Yet either way, the days of a singular polar reserve currency may soon be at an end, and how quickly its use expands beyond just the G20 will only be a matter of time.

After several months of aggressive selling of stocks in late 2015 and early 2016, the culprit for the indiscriminate liquidation and concurrent market swoon was revealed when it emerged that the seller was not only China (which was forced to sell USD-denominated reserves to offset a surge in capital outflows following the Yuan devaluation), but also Sovereign Wealth Funds belonging to oil-exporting countries, who were dumping billions in risk assets to offset the collapse of the price of oil, which in turn exacerbated current account and budget deficits.

Among the prominent sellers was Norway and Saudi Arabia, arguably the biggest casualties of the death of the Petrodollar to date, as well as Abu Dhabi, Kuwait and most other SWFs, listed on the tabel below.

 

As JPM calculated back in January, the SWF equity selling was inversely proportional to the price of oil: according to the bank, SWF’s would liquidate some $75 billion in equities in 2017 assuming oil at $31 per barrel. Needless to say, the lower oil goes, the more selling there would  be.

“This prospective $75bn of equity selling by SWFs in 2016 is not huge but becomes significant after taking into account the potential swing in equity fund flows,” JPM continued, in an attempt to discuss the impact this will have on markets. “Last year retail investors bought $375bn of equity funds globally. This year we expect an amount between 0 and $200bn. Subtracting $75bn of selling from SWFs would leave the overall equity flow from Retail+SWF investors barely positive for 2016.”

Then starting in February, oil – which had just tumbled to the low-$20s, its lowest price in over a decade – underwent a miraculous surge catalyzed by erroneous, if constantly reiterated, narrative of an imminent OPEC supply cut, a short squeeze, an algo stop hunt, an unprecedented Chinese importing spree to replenish its now almost full Strategic Petroleum Reserve, and even speculation of central bank intervention to prop up the “black gold.” In fact, just a few months after February, oil had doubled, reaching $50 even as we and many others warned, that there simply is not enough demand and far too much supply to sustain such a price.

No matter the cause, the biggest benefit of this oil surge is that the same SWFs which were actively selling stocks in early late 2015 and early 2016 put their liquidation on hold as oil rose above $40. And in this illiquid, low volume market, the absence of a determined seller is all that it took to push the S&P to all time highs, and as of Friday’s close, just shy of 2,200, a level which even sellside brokers such as Goldman believe is effectively in bubble territory and in the 99% percentile of all overvalued metrics.

However, just a few weeks later we are now back in a crude bear market, with oil briefly dipping under $40, on the back of concerns about a gasoline glut and fears that the resurgent dollar will further pressure oil. Worse, with oil returns back to the $40 range and threatens to accelerate the move to the downside, it also brings back with it the specter of SWF liquidations, because as JPM’s Nikolaos Panigirtzoglou points out in his latest weekly note, that’s where the wealth fund selling returns.

Here is why as oil approaches $40, the price of crude suddenly matters a lot to equity bulls:

 We had noted in F&L April 22nd what the impact would be of a $45 average Brent oil price on SWF behavior. At the time, we noted that the stability in oil prices meant that the pressure on SWFs to abruptly sell assets would diminish over time. In addition, we argued that SWF selling should focus more on fixed-income securities during the last three quarters of the year, given that SWFs mostly liquidated equity and HF mandates during last year and the first quarter of this year. However, given recent declines in oil prices, we revisit the analysis assuming an average oil price of $40 for 2016 vs $45 before. The YTD average has already fallen to $42.

In our previous analysis based on a $45 average oil price for 2016, we projected the current account balance for oil-producing countries to worsen from around -$70bn in 2015 to -$140bn in 2016. This estimate is based on the same sensitivity of the current account balance to the change in oil prices as last year, i.e. between 2014 and 2015. However, the depletion of official assets could be higher than the current account deficit if these countries also experience capital outflows as it happened last year. If we assume $80bn of capital outflow for 2016, the same level as last year, we project a depletion of $150bn in FX reserves and a depletion of $50bn in SWF assets.

If we assume an average oil price of $40 for 2016 instead, using a similar sensitivity analysis and assumptions as described above, we project the current account balance for oil-producing countries to worsen from around -$70bn in 2015 to -$183bn in 2016. This would imply depletion of $170bn in FX reserves and a depletion of $75bn in SWF assets.

 

The differences in the SWF selling using the two different average oil price assumptions can be seen in Figure 9.

 

 

A $40 average oil price, and assuming that these reserve managers and SWFs sell in accordance to their average allocation, would imply selling of $118bn of government bonds and $45bn of public equities. If we assume reserve managers and SWFs are mostly done with selling equities and that they are more likely to liquidate fixed-income mandates, this would imply selling of around  $120bn-$160bn of government bonds and $10bn-$15bn of corporate bonds. However, should oil prices continue to fall further below $40 on a sustained basis, SWFs would face greater pressure to sell equity mandates, similar to the end of last year and the beginning of this year.

Indeed: the lower the price of oil drops, the faster what until recently had been a paradoxical disconnect (and even a negative correlation between oil and risk assets as we showed earlier), will recouple. And it’s not just the SWF selling: recall that earlier this week, JPM’s head quant Marko Kolanovic warned that should oil return back to the $30s, it would also trigger program selling of stocks.

 CTA signals for oil recently turned from strongly positive to moderately negative. This has contributed to past-month divergence between S&P 500 and oil (~1.5 standard deviations) and is closely monitored by equity and high yield credit investors. It is our view that the risk of CTAs significantly increasing oil shorts over the next 1 month is low. For oil momentum to further deteriorate, oil would need to drop to ~$30 at which point the medium term momentum (strongest signal) would turn negative and trigger selling.

To summarize, if oil were to drop back under $40, not only would it precipitate even more selling of oil as momentum strategies flip, but it would catalyze a liquidation by those SWFs who thought they were done selling equities, leading to a return of the same sellers that pushed the S&P back to the low 1,900s a short 6 months ago.

So for all those curious where stocks are going next, the simple answer is: keep an eye on what oil does next.