07 Jan All That Glitters

“US Dollar hegemony is coming to an end.” – The Lonely Realist

Updating for events that have driven TLR themes over the last several years reveals that the erosion of American wealth and power – anchored by the US Dollar – has accelerated because of a combination of actions by the Axis of the Sanctioned, the Cold War strategies being successfully executed by China, more than two decades of American fiscal profligacy, and the fatal distraction of America’s tribal divisions.

Oil and gas

Russia, Iran and Venezuela, three members of the Axis, account for ~35% of the world’s proven oil reserves (and ~40% of OPEC’s production) and Saudi Arabia and other OPEC members account for a further ~40%, with the U.S., Canada and others totaling 25%.

The U.S. is unique among the 25% since the Shale Revolution has made it energy self-sufficient. Although America itself has minimal proven oil reserves (only 11 years’ worth), fracking yields strong front-loaded production. The U.S. consequently has no need to rely today on other countries to supply it with oil and gas. (Tomorrow, however, is less clear.)

Having few perceived strategic interests in the Middle East and Africa – the regions in which OPEC nations produce their oil and gas – has left it to China and Russia to fill the American vacuum, which is precisely what they have been doing.

This has not gone unnoticed among America’s former Middle East allies. China today is OPEC’s largest customer … as Chairman Xi emphasized at his recent meetings in Riyadh with members of the Gulf Cooperation Council (GCC).

The Ukraine sanctions

Countries that host two-thirds of the world’s population are not participating in U.S. sanctions against Russia. Many have been seduced by the Axis, including by incentives included in China’s Belt and Road Initiative. Others are wary of choosing sides. The only countries that are participating in Russia sanctions are America’s closest allies, Japan, South Korea, the EU, Great Britain, etc.

Not being constrained by sanctions, China, Turkey and India (among others) are buying oil and gas from Russia at hefty discounts that provide each with a competitive advantage over America and its allies.

At the historic early-December summit between China and the GCC, President Xi in the keynote address committed that China will continue to be a significant buyer of Middle East oil and gas and anticipates that China shortly will be paying for that oil and gas with China’s own currency, the Yuan. Saudi oil alone accounted for 17% of China’s imports last year and in November Qatar announced a 27-year natural gas deal with China. Asked if Saudi Arabia would agree to settling oil sales in the Yuan, the Saudi Foreign Minister said that he has “nothing to add.”

Might China be seeking to become the world’s energy middleman, buying oil and gas at fixed price discounts from Russia, Iran, Venezuela and the GCC and reselling the unused portion at a profit to the EU, Great Britain, Japan and others? After all, control of energy means control of the global economy.

Or perhaps China is seeking to create a Yuan alternative to the Dollar and sees oil and gas as the easiest first step in exalting the Yuan over the Dollar?

Both are true.

The Nuclear Dollar

America cut Russia off from the Dollar system shortly after Russia invaded Ukraine (as discussed in The Nuclear Dollar). Because Russia no longer can trade with the West, it is compelled to use its oil and gas to acquire goods from China, which has much (though far from all) of what it requires. It also compelled Russia to accept the Yuan as payment. China provides an alternate currency to Dollar hegemony for Russia and other Axis nations (as well as for other nations that so choose) to employ in trading for essentials.

This is the future envisioned by President Xi. With respect to the GCC, he emphasized use of “the Shanghai Petroleum and Natural Gas Exchange [by 2025] … for [Yuan] settlement in oil and gas … [with] China [committing] to import large quantities of crude oil on a long-term basis from GCC countries.” In addition, Xi offered significant investment (in part through its Belt and Road Initiative) and technological expertise.

The movement towards deglobalization has several consequences, one of which is that the Dollar no longer will continue as the one and only Reserve Currency. It will be the Reserve Currency for those nations that choose America’s payment system over the developing Chinese alternative. The industrial policy adopted by both the Trump and Biden Administrations of technological and manufacturing nationalism will face higher and higher costs as nations with resources that are critical for technology and manufacturing choose whether to settle in Dollars or in Yuan … and at what price. This will be inflationary for the West (and especially for Europe).

Putting the pieces together

The U.S. has prevented any nation or company it labels an enemy from using US Dollars, seized the assets of enemy nations, and threatened any nation or company that defies U.S. laws or sanctions with American jurisdiction and the full force of American power. China and its Axis allies, as well as previously non-aligned nations, are taking steps to insure that they, unlike Russia, are not snared in that American web.

The weaponized US Dollar peaked in September and has been falling since. It has more to fall.

The largest holders of US Treasuries, China and Japan, no longer are buyers. They are selling – for the first time since 2010, China holds less than $1 trillion.

Essential natural resources, notably oil and gas (but also copper, zinc, lithium, nickel, cobalt and rare earths), no longer are being bought and sold solely for Dollars. Resource nationalism is mirroring industrial nationalism.

When the Federal Reserve began printing Dollars in 2008, America’s national debt was $10 trillion. Today the national debt is $31.5 trillion. Interest to be paid on Federal debt soon will exceed $1 trillion/year.

America continues to overspend, as evidenced by the pork-filled $1.7 trillion “omnibus bill” agreed by both Parties and signed into law in December.

Because the foregoing is clear to the rest of the world, foreign national banks have been reducing their holdings of US Dollars. America’s “exorbitant privilege” therefore is evaporating. Some nations have decided to amass gold reserves in its stead … and at an accelerating pace. China, the world’s largest gold producer, does not disclose either its production or its purchases (Russia and Turkey were the #1 and #2 disclosed purchasers in 2022). If you were Xi Jinping, what more would you be doing to insure the Yuan against potential U.S. sanctions? At the same time, what might you be doing to increase confidence in the Yuan? Rest assured that China is doing everything possible.

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Finally (from a good friend)