January 9, 2023 0 Economic News RPM

By Selva Freigedo, 09/01/2023

In today’s Money Morning, the Russian invasion of Ukraine in 2022 has sped up the efforts to de-dollarise the global economy. In particular, moves to provide alternatives to the US dollar when it comes to oil payments could boost one commodity. Read on to find out more…

After Russia invaded Ukraine in 2022, sanctions against Russia made it clear that the US dollar could be used as a weapon…and that their assets held in US dollars could be frozen.

It’s with this in mind that during a conference in Kazakhstan, leaders from OPEC+, China, India, Brazil, and Pakistan, along with several African and Asian countries, decide to leave the International Monetary Fund and the US dollar.

Instead, they create a new monetary union with the Bancor — a new international accounting unit — at the centre of it.

Only member central banks will hold the Bancor, which will be used as a reserve asset and to settle international trades. And every member’s currency is backed by the Bancor.

This is an immediate and significant hit to the US dollar and its status as a global reserve currency.

The financial repercussions are soon felt around the world.

Central banks move to cut their US dollar reserves, treasury yields skyrocket, and the US dollar falls 25% versus a basket of currencies backed by the new asset.

Now, as you can probably tell, all this hasn’t happened.

The scenario is part of the ‘outrageous predictions for 2023’ — a set of forecasts Saxo releases every year.

As Saxo is quick to clarify, it is not the bank’s official forecasts but a thought experiment — extreme events that are possible but unlikely and could really change the economic landscape.

Some of their other ‘outrageous’ scenarios include the UK holding a second referendum on Brexit, which leads to the UK reversing Brexit and re-joining Europe, and even gold hitting US$3,000 an ounce.

I like exercises like these. It’s something I often do. Things rarely stay the same, and it helps to prepare for different outcomes.

But the de-dollarisation of the world economy and the end of the petrodollar is something that we’ve been moving towards for years…and another trend that the Russian invasion of Ukraine expedited.

The push for petrodollar alternatives

If you are not familiar with the petrodollar, here’s a short overview.

In 1973, the US negotiated a deal with Saudi Arabia. In exchange for pricing oil in US dollars, the US would provide military protection.

Since, at that time, most of the world bought oil from Saudi Arabia, it led to a major demand for US dollars. That was the beginning of the petrodollar.

By 1975, all the OPEC countries had agreed to price their oil only in US dollars.

Since then, the global oil trade is mostly conducted in US dollars.

Any country that wants to buy oil needs to exchange its currency for US dollars first. This makes the US dollar the world’s currency for commodities, in particular oil.

And it strengthened the US dollar by increasing its demand worldwide.

But as I say, there have been clear moves to move away for years.

In 2018, for example, China launched its first-ever yuan-denominated oil futures contract. Oil futures are contracts that determine the price of oil today to be delivered at a later date.

And more recently, at a summit in December, China invited Arab countries to use the Shanghai Petroleum and Natural Gas Exchange platform, which will be used to settle payments of oil and gas trading in yuan.

Having commodities priced in yuan gives China more pricing power. This is obviously a big advantage for China, which, in recent years, has become one of the largest importers of commodities in the world.

But it also gives the country more influence on exporting countries that depend on commodity exports.

I mean, in a way, that’s how the US dollar became dominant.

What’s more, pricing commodities in yuan also gives countries facing US sanctions a way to accept other currencies for oil.

If more countries stop using the US dollar for these agreements, it could have a huge effect on the demand for the US dollar. The petrodollar system only works as long as the US dollar maintains its prominence in global trade.

But there’s another risk for investors. As Zoltan Pozsar from Credit Suisse recently warned:

Fixed income investors should care — not just because the invoicing of oil in renminbi will hurt the dollar’s might, but also because commodity encumbrance means more inflation for the West.

My sense is that the market is starting to realize that the world is going from unipolar to multipolar politically, but the market has yet to make the leap that in the emerging multipolar world order, cross-currency bases will be smaller, commodity bases will be greater, and inflation rates in the West will be higher.

De-dollarisation can boost gold

The world is fragmenting as we speak, and it’s clear that things are changing. There’s inflation, but also trust in the US dollar is eroding.

A fact that shouldn’t get lost is that central banks were buying tons of gold in 2022…literally. In fact, central banks are hoarding gold at the fastest rate since 1967…

But in short, all this uncertainty is good for gold.

So, it may not happen this year, but it’s looking like we are moving away from the petrodollar system.

Meanwhile, gold is notching higher…


Selva Freigedo Signature

Selva Freigedo,
Editor, Money Morning