A Potential Petrodollar Shock with a Huge Impact on Markets
By Victor Sperandeo with the Curmudgeon
We explore a scenario where Saudi Arabia, acting alone or with all of OPEC, could replace the U.S. dollar as the currency used to price its oil, thereby causing a dollar crash that would have a shock effect on many markets.
Biden, Oil Prices and Saudi Arabia:
On his first day of office, President Biden issued an executive order canceling the Keystone XL pipeline making good on his promise to the climate activists who helped get him elected, but inviting a lawsuit brought by 21 states who say they will be hurt economically by Bidens decision.
That along with other anti-fossil fuel policies to effectuate the green new deal helped lift oil prices to + 50% this year. Biden then asked the Saudis to increase oil production to drive prices down [1.]. The Saudis said no.
Note 1. Rising oil prices and foreign policy blunders have sent Bidens approval ratings to the low-to-mid 40% level as per this graph:
On June 18th, the WSJ reported that the Biden administration instructed the Pentagon to remove approximately eight Patriot anti-missile batteries from countries including Iraq, Kuwait, Jordan and Saudi Arabia. The Terminal High Altitude Area Defense (THAAD) anti-missile system was also withdrawn from Saudi Arabia and jet fighter squadrons assigned to the region were also reduced. Those assets had been moved into Saudi Arabia following a 2019 strike on their oil production facilities. While claimed by Houthi forces in Yemen, U.S. officials assessed that Iran was behind that 2019 attack.
On September 11, 2021, the FBI released the first document related to the 9/11 attacks after Biden ordered the declassification of more records. Of consequence was a memo detailing "significant logistic support" that two of the Saudi hijackers received in the U.S.
After the U.S. defense support was reduced, the Saudis have been looking for one or more partners to protect themselves and the kingdoms oil reserves. For example:
1. On September 14th, Greece announced it would be sending U.S.-made Patriot anti-missile batteries and soldiers to staff them to Saudi Arabia, to replace U.S. manned Patriots the Biden administration withdrew in April.
In an opinion piece, Kenneth R. Timmerman of the NY Post wrote:
When Greece steps up to fill the vacuum left by a U.S. pullout, it gives you a measure of just how far the United States has retreated from the world stage over the past nine months. This is not the Greece of Alexander the Great, but todays Greece. Nearly bankrupt just a few years ago, Greece has now replaced the United States as defender of the worlds largest oil producer. Ouch.
2. Saudi Arabia has asked Israel about the possibility of procuring their missile defense systems, because of the U.S. defense systems the Kingdom has for so long relied upon have been removed. The Saudis are considering either the Iron Dome, produced by Rafael, which is better against short range rockets, or the Barak ER, produced by IAI, which is designed to intercept cruise missiles. Israeli defense sources told Breaking Defense that such a deal would be realistic, as long as both nations received approval of Washington. One source added that Saudi interest in the Israeli (defense) systems has reached a very practical phase.
If this tit for tat continues, one day soon well see Saudi Arabia ending the Petro Dollar [2.] monopoly of the U.S. They very well could persuade OPEC to ditch the dollar or take unilateral action to do so.
Note 2. Petrodollars are U.S. dollars paid to an oil-exporting country for the sale of crude oil. The petrodollar system is an exchange of oil for U.S. dollars between countries that buy oil and those that produce it. Oil importing countries pay for that commodity in U.S. dollars, which bolsters the greenback as the worlds reserve currency.
In my view, Saudi Arabia will look to a basket of currencies plus Gold/Silver to set the price of oil, as no other countrys fiat money today can be a reserve currency to replace the dollar. To be a reserve currency, a large and liquid debt market is required to invest in. You also need open and transparent capital markets. Chinas Yuan is out of contention on that basis, even though China is the worlds second largest economy and closing the GDP gap with the U.S.
A hypothetical Petrodollar replacement basket could be: Gold 10%, Silver 5%, U.S. Dollar 15%, China Yuan 15%, Euro 15%, Japanese Yen 15%, British Pound 4%, Canadian dollar 4%, Australian Dollar 4%, Russian Ruble 4%, Mexican Peso 2.5 %, Brazilian Real 2.5 %, Swiss Franc 2 %, Swedish Krona 2%.
Naturally if a currency was devalued too much in a year, the Saudis could lower the weight, and increase the percentage of stable or appreciating currencies.
Sidebar NOPEC and Ending the Petrodollar Hegemony:
In June 2019, Reuters reported that Saudi Arabia was threatening to sell its oil in currencies other than the dollar if Washington passes a bill exposing OPEC members to U.S. antitrust lawsuit. The No Oil Producing and Exporting Cartels Act (NOPEC) was a U.S. Congressional bill, never enacted, designed to remove the state immunity shield and to allow OPEC, and its national oil companies to be sued under U.S. antitrust law for anti-competitive attempts to limit the world's supply of petroleum and its consequent impact on oil prices.
Should this Petrodollar replacement occur, it would cause severe havoc in the U.S. and the rest of the western world. The dollar would sharply decline and that would cause U.S. inflation to spike. Stocks would immediately decline, while gold prices would increase sharply as markets went into chaos.
Is such a potential shock likely? I believe so, but governments have a lot of power to get around problems. One should be aware that Saudis de facto iron man leader, Mohammed Bin Salman al Saud (MBS) -pictured below, could make this decision for the Kingdom without OPEC's approval.
If it was announced on a weekend, many world equity markets would be limit down on Monday.
In addition, the dollars invested in Reverse Repos (started in March 2021) are up 1,000 % from $134 Billion on 3/31/21 to $1,313 trillion on 9/24/21. This is causing the credit markets to tighten and yields to rise.
What happens when the Fed unwinds the air on this balloon? The dollar declines!
The Petro dollar release valve described above could be the catalyst to cause inflation to rise and equity bull markets to collapse.
All of this Fed money printing and manipulation of fiat dollars would embarrass a sorcerer from the 14th century. It adds up to the magic of trying to make something from nothing without any consequences.
Only the naive inflationists could believe that government could enrich mankind through fiat money. Ludwig Von Mises
Stay healthy, enjoy life, success, good luck and till next time .
Follow the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
Copyright © 2021 by the Curmudgeon and Marc Sexton. All rights reserved.
Readers are PROHIBITED from duplicating, copying, or reproducing article(s) written by The Curmudgeon and Victor Sperandeo without providing the URL of the original posted article(s).