PETROYUAN: Institutional Investors May Have to Deal with a New World Order of Currencies
Posted on 03/15/2022
The catalysts of de-dollarization are more impactful as Washington utilizes economic sanctions as weapons against countries, including larger economies, stoking back-up plans for nations like China, India, Saudi Arabia, and Russia. The United States’ traditional allies in Europe, Russia, and China are irritated at the U.S. dollar’s dominance in international finance markets. Even global financial crises benefit the U.S. dollar. For example, the global financial crisis of 2008, which started in the U.S. (remember subprime mortgages) paradoxically strengthened the U.S. dollar’s dominance as a global safe haven. The Europeans were not able to do so with their eurozone debt crisis years after. The power of U.S. sanctions are linked to the centrality of the U.S. dollar in the global payment system. Hence, the rapid fire use of increased U.S. sanctions on Russia due to the country invading Ukraine over NATO expansionist fears caused a knock-on effect in the world of currencies. With Russia being excluded from SWIFT and the U.S. and European financial system, Russia is looking South and to the East for help. The U.S. sanctions on Venezuela or Iran, didn’t force countries to think about using alternative currencies for trade versus America’s response to Russia. China is becoming concerned about its holdings in U.S. assets, already having its “SOEs” exit the U.S. during the Trump administration, which sought to use tariffs on China – spurring the U.S.-China trade war. If China were to move on Taiwan, the Asian giant could face sanctions from the U.S. Thus, for China, in the long-term, using U.S. dollars is a potential hazard. In a countermeasure on Russia’s incursion in Ukraine, all G-7 countries moved to freeze Russia’s foreign currency reserve assets. Before Russia’s invasion of the Ukraine, the country amassed some US$ 500 billion of foreign currency reserve assets to shield itself from sanctions. That money remains frozen. The sanctions also targeted Russia’s two sovereign wealth funds – Russian National Welfare Fund and the Russia Direct Investment Fund (RDIF).
Institutional investors such as sovereign wealth funds, public pension funds, and to an extent reserve managers at central banks, are keeping watch on the developments of de-dollarization trends.
China’s Early Moves
The Sino giant studied and learned how the U.S. dollar became a world reserve currency. China sees the commodities market, including the oil market, as the insurance policy of the status of the dollar as reserve currency. The petrodollar was a key catalyst in making the dream come true, enabling the U.S. dollar and U.S. government to borrow more and more at cheaper rates over the decades. Approximately 80% of global oil sales are conducted in U.S. dollars. From the 1990s to 2010s, China played catch-up by being the workshop of the world and generating a massive pile of foreign exchange reserves. China’s indelible entrance into the World Trade Organization (WTO) and currency practices enabled China to produce vast wealth in the past two decades. In the 2010s, China made early strides to get its currency into more markets, as the Asian giant prodded its One Belt, One Road project (now known as Belt and Road Initiative – BRI). In 2016, China was able to get the yuan in the IMF’s special drawing rights (SDR) basket. SDRs are the IMF’s reserve asset, and are exchangeable for U.S. dollars, euros, sterling, yen and Chinese yuan or renminbi. Slowly, foreign central banks are more willing to hold RMB foreign exchange reserves and more open to use RMB in bilateral trade settlements. In 2018, Bloomberg added Chinese RMB-denominated government and policy bank securities to the Bloomberg Barclays Global Aggregate Index. In that same year, China pushed out yuan-denominated oil futures contracts in Shanghai, known as the petroyuan. China already started paying in yuan for crude oil imports from Russia and Iran (as early as 2012). On the Ex-Middle East front, China often engages in loan-for-oil deals in such cases with Angola, Russia, and Venezuela.
After World War II, the U.S. dollar became the main global reserve currency knocking off the British pound sterling from the pedestal. In 1974, U.S. President Richard Nixon saw the U.S. economy in a tailspin as inflation took off and the U.S. stock market crashed. The Nixon administration made secret overtures to Saudi Arabia, the influential member of the OPEC cartel. Nixon was greatly concerned if a deal with Saudi Arabia failed the Soviet Union could make further progress with the Arab oil producing nations. However, the U.S. was able to link a deal in which the U.S. would buy oil from Saudi Arabia and provide the kingdom with military equipment and a safe place to park their oil money. In return, Saudi Arabia would move billions of the petrodollar into Treasuries. The U.S. moved on this opportunity with other gulf countries as well. Saudi King Faisal bin Abdulaziz Al Saud requested the kingdom’s Treasury purchases stay strictly secret and the U.S. Treasury for a long time until Obama’s administration did not break out Middle East countries on Treasury holdings. U.S. President Trump was able to patch things up with Saudi Arabia and its new ruler Prince Mohammed (MBS). The Trump administration nixed the Iran nuclear deal – Joint Comprehensive Plan of Action (JCPOA), increased sanctions on Iran, and defeated ISIS (Islamic State) in Iraq and parts of Syria.
However, the Biden administration has so far failed to connect with Saudi Arabia. Saudi Arabia remains annoyed with the American’s lack of support in the Yemen civil war that started in 2014. The Yemeni Civil War is an ongoing multilateral civil war that began in late 2014 mainly between the Abdrabbuh Mansur Hadi-led Yemeni government and the Houthi armed movement, along with their supporters and allies. Saudi Arabia also witnessed the bungled U.S. exit of Afghanistan during the Biden administration and Biden’s attempt to reignite a deal with Iran over its nuclear program. To put icing on the cake, in 2020 when Biden campaigned for president he said Saudi Arabia should be treated as a “pariah” for the killing of Saudi journalist Jamal Khashoggi in 2018. Outside of Biden’s control was the U.S. relying less on Middle Eastern oil for a while. The U.S. was a top oil producer in the world due to advances in fracking. In the early 1990s, the U.S. used to import around 2 million barrels of Saudi oil per day. In December 2021, the number is less than 500,000 barrels per day.
Looking to China and India
Saudi Arabia is looking East to India and China as they become bigger buyers of oil. Over the past 40 years, China’s been importing massive amounts of oil. According to data from China’s General Administration of Customs, in 2021, Saudi Arabia was China’s top crude oil supplier selling at 1.76 million barrels a day. Russia came in at #2 selling China 1.6 million barrels a day. China is the largest buyer of oil from Saudi Arabia, buying more than 25% of Saudi Arabian oil exports. Since 2013, China has become the world’s largest net oil importer.
“Since the beginning of this year, under the combined influence of multiple factors such as the Covid-19 pandemic, the monetary policy shift of major economies, and especially the escalation of geopolitical conflicts, the international commodity price situation has become more severe, complex and uncertain,” Lian Weiliang, a Vice-Director at the National Development and Reform Commission (NDRC), said at a press briefing as handled by the South China Morning Post on March 9, 2022.
All of these factors are contributing to a proposition of Saudi Arabia accepting payments for oil in yuan. The Middle East’s acceptance of the yuan, would enhance China’s currency, in which China needs as it floats more yuan-denominated bonds. China has also helped Saudi Arabia on the military front and nuclear power front.
For now, Saudi Arabia conducts most of its oil deals in U.S. dollars, but these recent catalysts could cause de-dollarization trends to accelerate. Thus, a growing, larger U.S. fiscal deficit, will have a stronger impact on the U.S. economy. Political alliances are going to be a renewed area of concern for sovereign wealth investors and central bank reserve managers. The sanctions by the U.S. and other Western allies demonstrate that international relations between different states may play an important role in the safety of reserve assets. In addition, the sanctions have given more light on the major difference between a foreign exchange deposit under the jurisdiction of a foreign government and one that a country owns in one’s homeland. While both might be considered cash, they are not equivalent in terms of accessibility or safety. There could be a trend in which some reserve managers could bring their foreign exchange assets onshore. SWFI research has already witnessed the trend of countries buying more physical gold and storing it locally. Furthermore, this analysis has only focused on fiat currencies and have not addressed the rise of cryptocurrencies and its acceptance by wider consumer adoptions, business adoption, and government acceptance.