Nick
Giambruno’s Note: I recently spoke with my friend and
colleague Chris Lowe about China’s new alternative financial system—and how it
could mortally wound the US dollar. It was such an important discussion that I
had to pass it along.
Chris
is the editor of Bonner & Partners’ Inner Circle.
His publication shares insights from Bill Bonner’s personal global network
of analysts and investment experts.
Using
force to compel people to accept money without real value can only work in the
short run. It ultimately leads to economic dislocation, both domestic and
international, and always ends with a price to be paid.
– Former U.S. Congressman Ron Paul
He who
holds the gold makes the rules.
– Old saying
Chris
Lowe: Why did you start researching the petrodollar system and its
potential unraveling?
Nick
Giambruno: This has been on my radar since 2006. That’s when Ron
Paul, then a Republican congressman, spoke to Congress about the collapse of
the dollar-based global monetary system.
As I
recently told my Crisis Investing readers, I think it’s his
most important speech ever. It’s called “The End of Dollar Hegemony.”
During
the speech, Dr. Paul lays out why a global monetary order built around a fiat
currency is doomed to fail.
Crucially,
he pointed out the one thing that would precipitate the US dollar’s
collapse—the end of the petrodollar system.
I
recommend reading the speech in full.
But this is the most important part:
The economic law that honest exchange
demands only things of real value as currency cannot be repealed. The chaos
that one day will ensue from our 35-year experiment with worldwide fiat money
will require a return to money of real value. We will know that day is
approaching when oil-producing countries demand gold, or its equivalent, for their
oil rather than dollars or Euros.
I
discussed this with Dr. Paul at a past Casey Research conference. He told me he
stood by his assessment.
In a
nutshell, he’s saying we’ll know the dollar-centric monetary system is on its
way out when countries start trading oil for gold instead of dollars.
That’s
already starting to happen.
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Chris
Lowe: To catch up real quick, why is the petrodollar at risk?
Nick
Giambruno: Under the current petrodollar system, all global oil sales are
made in dollars. However, the Chinese government recently announced a new
mechanism that will allow oil producers anywhere in the world to trade oil for
gold.
China’s
new mechanism will totally bypass the US dollar and the US financial system…
along with any restrictions, regulations, or sanctions from Washington. So for
many oil producers, it will be much more attractive than the petrodollar
system.
I call
it China’s “golden alternative” to the petrodollar. Whatever you call it,
though, it will allow for the large-scale trade of oil for gold, instead of
dollars.
Here’s
how it will work. The Shanghai International Energy Exchange is launching a
crude-oil futures contract denominated in yuan, China’s currency. This will
allow oil producers around the world to sell their oil for yuan.
Of
course, the yuan is a fiat currency, just like the dollar. And most oil
producers don’t want large stashes of yuan. The Chinese government knows this.
That’s why it’s linked the crude-oil futures contract with the option to
efficiently convert yuan into physical gold through gold exchanges in Shanghai
and Hong Kong.
Chris
Lowe: How soon will this new system be up and running?
Nick
Giambruno: I spoke with officials at the Shanghai International
Energy Exchange. They told me they plan to go live with it before the end of
the year, or shortly thereafter.
Chris
Lowe: But isn’t that a good thing? Isn’t gold, as a currency,
more reliable than the dollar?
Nick
Giambruno: I think it’s high time gold played a more central role in the
global monetary system. The problem is ditching the petrodollar would
negatively affect the US economy.
Think
about it. If Italy wants to buy oil from Kuwait… or Argentina wants to buy oil
from Brazil… they have to buy dollars on the foreign exchange market first.
This
creates a huge artificial market for dollars.
It
means the US can simply print dollars and exchange them for real things like
French wine, Italian cars, Korean electronics, or Chinese manufactured goods.
It also
helps create a deeper, more liquid market for US Treasury bonds. This pushes up
prices… and pushes down yields… which allows the US federal government to
finance enormous and permanent deficits.
The
petrodollar has allowed Washington to spend astronomical amounts of money on
welfare and other benefits for over half the population. This gives Americans a
much higher standard of living than they would have otherwise. Most of them
don’t know this or understand how it affects their everyday lives.
Thanks
to the petrodollar, Washington can also sanction or exclude virtually any
country from the dollar-based global financial system at the flip of a switch.
By extension, it can also cut off any country from the vast majority of
international trade.
Chris
Lowe: Others have argued that this has led the US Deep State
into military actions against anyone who threatens the petrodollar system. Is
the Deep State that scared about the effects this could have on the economy and
on its position as the world’s top power?
Nick
Giambruno: Let’s put it this way, world leaders who have challenged
the petrodollar system have ended up dead. Saddam Hussein and Muammar Gaddafi
are prime examples.
In
October 2000, Saddam started to sell Iraqi oil in euro only. He said Iraq would
no longer accept dollars for oil because it did not want to deal in the
“currency of the enemy.”
A
little over two years later, the US invaded Iraq. After Baghdad fell to US
forces, all Iraqi oil sales were switched back to dollars.
And
thanks to WikiLeaks’ release of Hillary Clinton’s emails, we know that
protecting the petrodollar—not humanitarian concerns—was the main reason for
America’s involvement in the ousting and killing of Libyan leader Muammar
Gaddafi.
According
to the leaked emails, the US—along with France—feared Gaddafi would use Libya’s
vast gold reserves to back a pan-African currency. This gold-backed currency
would have been used to buy and sell oil in global markets. It would have
likely displaced the CFA franc—a version of the euro used in 14 central and
west African nations.
As I’m
sure you recall, the US and France backed a rebellion that overthrew Gaddafi in
2011. After his death, plans for the gold-backed currency—along with Libya’s
4.6 million ounces of gold—vanished.
Chris
Lowe: What’s Russia’s role in all of this?
Nick
Giambruno: The dollar is not just a currency. It’s a political
weapon… and Washington is not shy about using it.
Most
recently, it tried to punish Russia for its actions in Ukraine by imposing economic
sanctions. This made it harder for Russia to access the dollar-based financial
system. So it’s no surprise that Russia struck a deal to sell oil and gas to
China for yuan afterward.
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Chris
Lowe: How big a deal is it that Russia is working with China on
bypassing the dollar?
Nick
Giambruno: Russia is one of the world’s largest energy producers. And
China is the world’s largest energy importer. Historically, they would trade
with each other exclusively in US dollars.
But the
Shanghai International Energy Exchange futures contract will streamline and
solidify the process of selling oil to China for yuan—or effectively for gold.
When
two of the biggest players in the global energy market totally bypass the
petrodollar system, it’s a very big deal.
And
it’s not just Russia and China. Other countries want to sidestep the US
financial system and US economic sanctions, too. China’s “golden alternative”
will give them the option to do just that. This will make the US dollar a much
less effective political weapon.
Take
Iran, for example. It’s the world’s fifth-largest oil producer. And it’s now
accepting yuan as payment for its oil. So is Venezuela, which has the world’s
largest proven oil reserves. I think others will soon follow.
This
all makes perfect economic sense. Oil-producing nations can continue with the
petrodollar system and sell their oil for dollars. But there’s not much
financial incentive to do that anymore. The Fed has deliberately pushed down US
Treasury yields to “stimulate” economic growth. Plus, the system exposes US
rivals to the whims of Washington.
Now oil
producers have a second option. Through China’s “golden alternative,” they can
sell their oil for yuan, then quickly and easily convert it to gold.
Unlike
the dollar, gold is an international form of money with no political risk. From
the perspective of an overseas oil producer—especially one with a poor
relationship with the US—this is a no-brainer.
Chris
Lowe: Russia may be one of the world’s largest oil producers.
But Saudi Arabia is still the world’s largest oil exporter. And a lot of that
oil goes to China, the world’s largest oil importer. The Saudis were also
America’s partner in the petrodollar agreement back in 1974. Can’t the House of
Saud use this influence to protect the petrodollar system?
Nick
Giambruno: For now, the Saudis are refusing to participate in China’s
“golden alternative.” That’s because selling oil for anything but dollars would
break the petrodollar deal they made with the US back in 1974. Remember, the
Saudis agreed to sell their oil exclusively in dollars in return for US arms
and military protection.
Last
year, on the campaign trail, Donald Trump said, “If Saudi Arabia was without
the cloak of American protection, I don’t think it would be around.” He’s
absolutely correct. If the Saudis started selling oil for yuan, they would
immediately lose American diplomatic and military protection.
But
Saudi Arabia is already looking for alternatives to American protection.
Chris
Lowe: Who is it turning to?
Nick
Giambruno: This is where the story gets really interesting. Russia and
Saudi Arabia have been enemies for decades. The Saudis, along with the US,
supported the Afghan mujahideen that drove the Soviet Army out of Afghanistan.
The Saudis also supported a number of Chechen rebellions against Russia. And
more recently, the Saudis and Russians have been on opposite sides of the
Syrian Civil War.
But
recently, the Saudi king—along with 1,500 members of his royal entourage—visited
Moscow. It was the first official visit by a Saudi king to Russia. The trip
coincided with a $10 billion Saudi investment in Russian energy projects and a
$3 billion arms deal.
As part
of that deal, the Saudis will buy Russia’s S-400 missile system. It’s arguably
the most capable air defense system in the world. It’s a powerful deterrent to
even US fighter jets.
Chris
Lowe: I didn’t know the Saudis bought Russian weapons systems.
Nick
Giambruno: They didn’t… up until now. Ever since the birth of the petrodollar,
the Saudis have depended on American military protection. After all, it’s what
they get in return for pricing their oil in dollars.
Chris
Lowe: So why would the Saudis enter into an arms deal with
Russia?
Nick
Giambruno: The Saudis are hedging their bets. First, they’re not
buying an American-made air-defense system. Second, they’re buying a Russian
air-defense system that’s capable of deterring an American attack. The House of
Saud is making significant moves, in other words, to give itself alternatives
to American protection.
Chris
Lowe: Is there any other evidence that Saudi Arabia is moving
away from the US?
Nick
Giambruno: Last August, Saudi Arabia announced it was willing to issue
“Panda bonds” to finance its government spending deficit. These are
yuan-denominated bonds from non-Chinese issuers that are sold in China.
This is
remarkable. The Saudi currency, the riyal, is pegged to the dollar. Up until
this point, Saudi Arabia has exclusively used US dollars for all of its major
financial initiatives. Issuing debt in yuan is a significant move. It means
that financially, Saudi Arabia is drifting closer to China.
Chris
Lowe: Why does Saudi Arabia need to hedge its bets like this?
Nick
Giambruno: A few years ago, Saudi oil made up over 25% of Chinese oil
imports. They were Beijing’s No. 1 supplier. Today, the Saudis’ market share
has dropped below 15%.
The
Saudis are losing massive market share and getting pushed out of the biggest
oil market in the world—mainly because they refuse to sell oil to China in
yuan.
China
has made itself clear. It’s willing to expand business with anyone who will
accept yuan as payment.
Chris
Lowe: If the Saudis bow to Chinese pressure, where does all that
leave the petrodollar system?
Nick
Giambruno: The Saudis haven’t made a clean break with the US and the
petrodollar—yet. But they are drifting toward China financially and Russia
militarily. These moves are already sidelining the petrodollar. The Saudis are
clearly setting up the option to dump the petrodollar.
If the
Saudis start to sell oil to China in yuan, it would kill the petrodollar
overnight.
Short
of that, things still look very dire for the petrodollar. What is baked into
the cake—thanks, in large part, to China’s “golden alternative”—is the
petrodollar’s significant erosion.
Chris
Lowe: What specific advice do you have based on this prognosis?
Nick
Giambruno: The increased demand for gold from China’s “golden
alternative” to the petrodollar is going to shock the gold market. And this
demand shock clearly hasn’t been priced into the gold market yet. As many of
your readers will be aware, gold is still down significantly from its 2011
peak.
That’s
why I am so bullish on gold right now. As the petrodollar dies, gold is going
to replace it as the go-to currency for the oil trade. That makes the yellow
metal the single best way to profit from this major shift in our monetary
order.
I
started warning about the end of the petrodollar late last year. That’s when I
told Crisis Investing readers that the death of the
petrodollar would be the No. 1 black swan event of 2017.
Eventually,
people will look back and see China’s “golden alternative” as the catalyst that
made it happen.