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Has de-dollarization begun?

Commentaries & Views

"There are decades where nothing happens; and there are weeks where decades happen"

-Vladimir Ilyich Lenin, Soviet dictator

As I understand it, Lenin was a horrible tyrant. But that quote is just too fitting.

It looks like major changes are coming to the international financial system. The U.S. dollar may be at a crossroads, and its status as an undisputed world reserve currency could be in play.

Credit Suisse analyst Zoltan Pozsar summed it up well in a recent note to clients titled Bretton Woods III.

Pozsar explains how this crisis has the potential to be far more potent than the 1973 oil embargo. He says the factors at play are much larger in scale, and the commodity system is far more financialized and leveraged than it was in "73. This simply multiplies systemic risk.

Commodity Markets Crack

We have already seen these disruptions break markets. The London Metal Exchange (LME) recently shut down trading in nickel as the price tripled (Russia is the largest nickel exporter).

It turns out a very large nickel trader was caught short massive amounts of contracts, and allegedly JP Morgan was the most exposed counterparty.

The LME went so far as to cancel $4 billion worth of trades, and has since had to shut down trading multiple times and limit price movements. The LME is a dominant player in commodity trading, but this may shake traders' confidence in the system.

More systemic disruptions are possible if this economic war continues.

We did get one piece of good news on Thursday, March 3. The U.S. Treasury Department announced that it wouldn't stop Russia from making a $117 million bond payment through Citigroup. That means Russia may not default on its debt, which could set off a cascade of financial chaos in Europe and the U.S.

Most importantly, this shows that economic diplomacy is still happening. A fresh global financial crisis isn't in anyone's best interest.

De-Dollarization in Play?

In his report, Credit Suisse analyst Pozsar also explains how the U.S./EU seizure of Russian central bank assets could lead other countries to start shifting away from the dollar/Eurodollar system to a new one.

Central bankers don't like the idea of someone else controlling their financial resources. So, there has long been a theory that countries would start to de-dollarize.

What would de-dollarization look like? On March 15 we may have gotten a hint when The Wall Street Journal reported that Saudi Arabia was in talks with China to sell oil in yuan (China's currency). Here's an excerpt.

The talks with China over yuan-priced oil contracts have been off and on for six years but have accelerated this year as the Saudis have grown increasingly unhappy with decades-old U.S. security commitments to defend the kingdom, the people said…

China buys more than 25% of the oil that Saudi Arabia exports. If priced in yuan, those sales would boost the standing of China's currency. The Saudis are also considering including yuan-denominated futures contracts, known as the petroyuan, in the pricing model of Saudi Arabian Oil Co ., known as Aramco.

Saudi Arabia has only priced its oil in dollars since 1974. It would be a major shift if they began selling 25% in China's currency, the yuan or RMB. (Note: we talked more about this issue in Bitcoin, Inflation and the Big Macro Picture two weeks ago.)

According to the Global Times, a China state-affiliated media outlet, India is also exploring the yuan for oil purchases from Russia.

India is reportedly planning to buy Russian oil at discounted prices and even considering the Chinese yuan as a reference currency in an India-Russia payment settlement mechanism, a move that Chinese analysts say represents the growing frustration among world economies over the US-led sanctions against Russia that have rattled global markets.

Together, India and China combine to make up about 36% of the global population and 22% of global GDP. If these countries do follow through with their de-dollarization plans, it would have major effects on the dollar long-term. To be clear, these countries may just be bluffing, or strengthening their negotiating position. But they may be quite serious.

The U.S. is currently highly dependent on cheap imports, largely from India and China. Those imports are inexpensive due to the dollar's overwhelming strength versus foreign currencies.

If the dollar falls significantly versus China's yuan, for example, that has the potential to further fuel price spikes. It could also mean that the Fed needs to step in as the primary buyer of Treasury bonds, which may compound inflationary pressures, as the money to buy our debt issuance is freshly printed.

It's not all negatives, however. If the dollar does fall over coming years, the U.S. will be in a position to rebuild its manufacturing base and become an industrial powerhouse once again.

Don't get me wrong, the U.S. and its allies still have plenty of powerful levers that can be utilized in negotiations. So, if this financial battle drags on, there will be plenty of pain to go around.

Crypto's Role

Crypto certainly has a role to play in the coming turmoil.

If the financial war continues it seems probable that investors will continue to adopt apolitical cryptocurrencies such as Bitcoin and Ethereum. Scarce, decentralized, self-custodied digital money has natural attractions in such a situation.

If inflation is as problematic as many of us expect it to be over the next few years, sovereign assets like BTC have the potential to do quite well.

Considering what we are seeing occur today, it could be a matter of time until we see another country announces it is adding BTC to its reserves, as El Salvador did. If multiple countries jump on that bandwagon, things could get very interesting.

Central banks adopting Bitcoin in larger numbers may still be a ways off, mostly because there are many other things for central bankers to worry about at the moment.

Then again, all the things those bankers are worrying about may eventually lead them to ponder the utility of digital gold.


Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.