As evidenced by this week’s news flow (see below) the narrative around de-dollarisation is not going away despite a number of influential pundits suggesting it’s just that – a narrative with little substance.
A big week for multi-currency energy and commodities
China completes first CNY-settled LNG trade – 3/29/23 Bloomberg
Riyadh joins Shanghai Cooperation Organization as ties with Beijing grow – 3/29 Reuters
Brazil’s Central Bank quadruples exposure to CNY – 3/31/22 Reuters
China says it will set up CNY clearing arrangements with Brazil – 2/7/23 Reuters
One of the main objections is that the renminbi (CNY) is not fully convertible. However, as we will see there is significant two way trade between China and the energy/commodity producing countries – a quarter of Brazil’s imports are with China. Any balance of CNY after settling trade can be converted into gold on the Shanghai Gold Exchange.
As a home for surplus trade balances gold has done very well against the traditional bolt hole of US Treasuries.
Gold v US 10year Treasury - chart courtesy of Trading View
There are a number of missing links in the de-dollarisation arguments covered by the inestimable Luke Gromen at “Forest for the Trees FFTT”
To understand what is happening and why, one must start with energy and in particular oil, and then work backward from there:
• • First, understand how much of a country’s negative or positive trade balance is driven by energy imports or exports.
• • Second, understand what would happen to an energy importing nation’s trade balance if it could import its energy in a currency it can print, or what reserve asset an oil exporter could store non-USD surpluses in (gold.)
• • Third, understand how much less foreign FX reserve UST demand there will be from these oil importers and oil exporters over time as the marginal oil barrel can be priced in non-USD (not is, just can be, because the marginal barrel prices the whole, so marginal barrel in non-USD will increase the ability for these nations to control their FX x-rates v. the USD.)
• • Fourth, understand how much US deficits (UST issuance) are going to rise no matter what given structural deficits and now rising interest rates.
• • Fifth, understand that the US government will crowd out global USD markets to finance those deficits that foreigners are increasingly not financing, driving USD up and everything else down, until that “USD up, everything else down” threatens the US government’s own solvency (True interest expense > receipts, UST volatility up).
• • Sixth, understand once point No.5 happens, the Fed and/or Treasury will eventually print money to finance those deficits, but try to convince western investors they are not doing so and that their actions will not be inflationary.
The pain and discrediting this outcome will cause US policymakers will likely mean they will try to hold out for as long as possible before being forced into it.
It is not as if the demise of the petrodollar (which we wrote about here) is something new, but loss of recycling petro/commodity income into US Treasuries is becoming an increasing problem given the ever increasing level of issuance. The other interesting observation is that in a period of rising real rates the price of gold has been rising too.
US 10 Year Real Yield - chart courtesy of St Louis Federal Reserve FRED
This positive correlation should be a negative one. The reason being that US Treasuries are not holding their own against oil, so “settlement” in gold is becoming the preferred option. This is exactly what happened back in the 70s and Volcker eventually had to take US rates to 15%, and US 10y real rates to nearly 8% (see chart above) and as Luke Gromen puts it,
to stop gold from being turned into the primary oil settlement asset (thereby defending the USD, the UST market, and establishing USTs as the primary reserve asset for the next 40 years).
He continues.
Could you imagine the Fed raising to 8% real rates on the 10 year? The system would collapse well before the Fed ever got to 8% real rates. The point is that the debt/GDP, deficit/GDP, and demographic (62% of tax receipts going to Boomer entitlements) context of now v. 1975 is apples and oranges.
The Fed cannot do what it needs to do to stop gold from being turned into a primary oil settlement asset without blowing up the UST market and the US and global economy overall This is critical context left out by many other commentators.
A repeat of the 1970s would imply a gold price up near $9,000/oz by 2027-28. This is not a forecast; a week in markets is a long time, let alone 5 years from now, but a further reminder from history is that back in the 70s most institutional portfolios held around 10% in gold and gold mining shares.
De-dollarisation is not happening all at once, but slowly and the writing is surely on the wall. What comes next? Gold has to be in the mix, doesn’t it?