Why The Great Petrodollar Unwind Could Be $2.5 Trillion Larger Than Anyone Thinks

Tyler Durden's picture

Last weekend, we explained why it really all comes down to the death of the petrodollar. 

China’s transition to a new currency regime was supposed to represent a move towards a greater role for the market in determining the exchange rate for the yuan. That’s not exactly what happened. As BNP’s Mole Hau hilariously described it last week, "whereas the daily fix was previously used to fix the spot rate, the PBoC now seemingly fixes the spot rate to determine the daily fix, [thus] the role of the market in determining the exchange rate has, if anything, been reduced in the short term." Of course a reduced role for the market means a greater role for the PBoC and that, in turn, means FX reserve liquidation or, more simply, the sale of US Treasurys on a massive scale. 

The liquidation of hundreds of billions in US paper made national headlines this week, as the world suddenly became aware of what it actually means when countries begin to draw down their FX reserves. But in order to truly comprehend what’s going on here, one needs to look at China’s UST liquidation in the context of the epochal shift that began to unfold 10 months ago. When it became clear late last year that Saudi Arabia was determined to use crude prices to bankrupt US shale producers and secure other "ancillary diplomatic benefits" (think leverage over Russia), it ushered in a new era for producing nations. Suddenly, the flow of petrodollars began to dry up as prices plummeted. These were dollars that for years had been recycled into USD assets in a virtuous loop for everyone involved. The demise of that system meant that the flow of exported petrodollar capital (i.e. USD recycling) suddenly turned negative for the first time in decades, as countries like Saudi Arabia looked to their stash of FX reserves to shore up their finances in the face of plunging crude. Of course the sustained downturn in oil prices did nothing to help the commodities complex more broadly and as commodity currencies plunged, the yuan’s dollar peg meant China’s export-driven economy was becoming less and less competitive. Cue the devaluation and subsequent FX market interventions.

In short, China’s FX management means that Beijing has joined the global USD asset liquidation party which was already gathering pace thanks to the unwind of the petrodollar system. To understand the implications, consider what BofAML said back in January:

During the oil-boom era, oil-exporters used oil earnings to finance imports of goods and services, and channeled a portion of surplus savings into foreign assets. ‘Petrodollar’ recycling has in turn helped boost global demand, liquidity and asset prices. With the current oil price rout, external and fiscal balances of oil exporters are undermined, and the threat of lower imports and repatriation of foreign assets is cause for concern.

Recycling of Asia-dollars might partly replace the recycling of petrodollars.  Asian sovereign wealth funds ($2.8tn) account for about 39% of total sovereign wealth funds, and will likely see their size increase at a faster clip. Sovereign wealth funds of China (CIC & SAFE), Hong Kong (HKMA), Singapore (GIC & Temasek) and Korea (KIC) rank in the Top-15 globally

Yes, the "recycling of Asia-dollars might partly replace the recycling of petrodollars." Unless of course a large Asian country is suddenly forced to become a seller of USD assets and on a massive scale. In that case, not only would the recycling of Asian-dollars not replace petrodollar recycling, but the "Eastern liquidation" (so to speak) would simply add fuel to the fire - and a lot of it. That’s precisely the dynamic that’s about to play out. 

A careful reading of the above from BofA also seems to suggest is that looking strictly at official FX reserves might underestimate the potential size of the petrodollar effect. Sure enough, a quick check across sellside desks turns up a Credit Suisse note on the "secular downtrend in EM reserves" which the bank says could easily be understated by focusing on official reserves. 

First, note the big picture trends (especially Exhibit 2):

And further, here’s why the scope of the unwind could be materially underestimated.

Taken into context, the year-to-date fall in EM reserves accounts for only 2% of the total stock of EM reserves. However, the change in the behavior of EM central banks from persistent buyers to now sellers of reserve assets carries important implications. Importantly, official reserves will likely underestimate the full scale of the reversal of oil exporters’ “petrodollar” accumulation.


Crucially, for oil exporting nations, central bank official reserves likely underestimate the full scale of the reversal of oil exporters’ “petrodollar” accumulation. This is because a substantial part of their oil proceeds has previously been placed in sovereign wealth funds (SWFs), which are not reported as FX reserves (with the notable exception of Russia, where they are counted as FX reserves).

  • Currently, oil exporting countries hold about $1.7trn of official reserves but as much as $4.3trn in SWF assets.
  • In the 2009-2014 period, oil exporters accumulated about $0.5trn in official reserves but as much as $1.8trn of SWF assets.

Now that the tide has turned, it is likely that not only official reserves drop but that SWF asset accumulation slows to nil or even reverses. SWF selling may be a slower process as assets tend to be less liquid, but the opportunity might still be taken to repatriate some investments, for instance to boost domestic rather than foreign infrastructure projects. 


In other words, looking at the total amount of official reserves for oil exporters understates the potential for petrodollar draw downs by around $2.5 trillion. Now obviously, it's unlikely that exporters will exhaust the entirety of their SWFs. Having said that, the fact that EM FX reserve accumulation turned negative for the first time in history during Q2 underscores how quickly the tide can turn and how sharp reversals can be. If one fails to at least consider the SWF angle then the effect is to underestimate the worst case scenario by $2.5 trillion, and if 2008 taught us anything, it's that failing to understand just how bad things can get leaves everyone unprepared for the fallout in the event the situation actually does deteriorate meaningfully. 

So that's the big picture. In other words, the above is a discussion of the pressure on accumulated petrodollar investments and is an attempt to show that the pool of assets that could, in a pinch, be sold off to finance things like massive budget deficits (Saudi Arabia, for instance, is staring down a fiscal deficit that amounts to 20% of GDP) is likely being underestimated by those who narrowly focus on official reserves. Switching gears briefly to consider what $50 crude means for the flow of petrodollars (i.e. what's coming in), RBS' Alberto Gallo has the numbers:

If petroleum prices continue in to year end at their current YtD average ($52), this would represent a 60% decline in Petrodollar generated in 2015 vs between 2011 and 2014. Assuming that 30% of gross Petrodollars generated per year are invested in financial markets, this would imply $288bn ready for investments in 2015 vs a $726bn average between 2011 and 2014. Lower purchasing power from oil-exporting countries may in turn reduce demand for $-denominated fixed income assets, including $ IG and $ HY. US IG and HY firms have issued $918bn and $220bn YtD, which in total marks a record-high vs past years. 



And while all of this may seem complex, it's actually quite simple: less petrodollars coming in without a commensurate reduction in what's going out means the difference has to be made up somewhere and that somewhere is in the sale of USD reserve assets which are prone to being understated if one looks only at official FX reserves. Contrast this with the status quo which for years has been more petrodollars coming in than what's going out (in terms of expenditures) with the balance being reinvested in USD assets.

Simplifying even further: the virtuous circle (for the dollar and for USD assets) has not only been broken, but it's now starting to reverse itself and the potential scope of that reversal must take into account SWF assets. 

Where we go from here is an open question, but what's clear from the above is that between China's FX reserve drawdowns in defense of the yuan and the dramatic decrease in petrodollar flow, the self-feeding loop that's sustained the dollar and propped up USD assets is now definitively broken and we are only beginning to understand the consequences. 

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JustObserving's picture

Obama's plan to attack Putin by crashing oil prices is backfiring.  But then Obama has failed at everything but killing brown people and defending the NSA/CIA infinte spying on the American people and signing NDAA.


Think about how the Obama administration sees the state of the world. It wants Tehran to come to heel over its nuclear programme. It wants Vladimir Putin to back off in eastern Ukraine. But after recent experiences in Iraq and Afghanistan, the White House has no desire to put American boots on the ground. Instead, with the help of its Saudi ally, Washington is trying to drive down the oil price by flooding an already weak market with crude. As the Russians and the Iranians are heavily dependent on oil exports, the assumption is that they will become easier to deal with.

John Kerry, the US secretary of state, allegedly struck a deal with King Abdullah in September under which the Saudis would sell crude at below the prevailing market price. That would help explain why the price has been falling at a time when, given the turmoil in Iraq and Syria caused by Islamic State, it would normally have been rising.


CaptainAmerika's picture
CaptainAmerika (not verified) JustObserving Aug 29, 2015 5:15 PM

An empire founded by war has to maintain itself by war

johngaltfla's picture

Nicely done Tyler. And the funny part is all the nations stupid enough to buy and peg reserves to the USD which will get destroyed in the process. When Singapore and Hong Kong de-peg, it is over boys and girls.

Slave's picture

Only when the Chosens are done buying up US shale producers, will oil return to the new normal.

pretty bird's picture

Deflation, deflation, deflation.  The petro-dolla is here to stay.  Learn it, live it, love it.

Perimetr's picture

Temporary deflation, due to a loss in liquidity, which causes the Central banks to send an even larger tidal wave of electronic fiat currency to "fix" it

Hyperinflation follows, the dollar self-destructs, Treasury notes follow, which rapidly devalue while the world abandons the dollar and returns to the gold standard

Leaving the US in the third world.

Remember the jokes about Russia being a "third world country with nukes"?

Shoe soon to be on the other foot . . . only unlike Russia, the US is likely to use them.

Klemens's picture
Klemens (not verified) CaptainAmerika Aug 30, 2015 6:47 AM

please read this book:

The Globalization of War


the Petro-Dollar is the war against all humans!


KnuckleDragger-X's picture

Trade value, no trade = no value. The fun part is when the rest of the world tells us to go away and then ignores us......

Son of Captain Nemo's picture

And what a fine strategy it is?...

Create massive over capacity to the market by looting the hell out of every other ME country's reserves (which has been non-stop since 9/11) to destroy Russia and Iran's revenue "party" which everyone by now knows was the objective 14 years ago... Trouble is according to the town crier of the Aspen Institute General "Let's start a nuclear war over an airport in the Balkans"... It was only supposed to take 5 years and ended up taking much longer and at a much more exorbitant price than was previously anticipated!

That "overcapacity" can be systematically fucked in a major way... Sabotage to those reserves comes to mind and will be the perfect segue for either side in the event the Anglo-American team decides to get another "wild hair up it's ass"to put it's helmet back on again only this time for the last major ass kicking unlike any they have ever had before!!!

I guess for the truly delusional and criminally insane it's a fun way to end both the party and your life!

Trouble with this behavior is that the rest of the 99% probably don't see it this way?!!!

Jack Burton's picture

Always good posts Captain Nemo! The Iranians have said that should Israel, the USA or Saudi Arabia participate in an attack on Iran, then Saudi oil fields would see a hail of missiles arrive on refineries, Shipping facilities , key pipeline junctions. Iran has build crusise and ballistic missiles to spread their attack around both low altituded and high altitude. So YES, IF the USA plays it's cards Too hard, Iran will burn the fucking Saudi Oil.

Russia, while still bending over backwards to please the EU, can be counted on to burn some Saudi Oil if need be. Russia has till now been peaceful. But they might just begin to fund their own favorite anti Saudi groups! Then things will change fast.

wrs1's picture

All they got to do is hit an electric plant.  Didn't you see whree the Houthi's aimed the Scud?  Saudi electric plants are all oil fired, they will go up like a ball of flames if hit by a scud and then it's lights out and pipelines stopped.

MSimon's picture

Russia is peaceful? Really?

Nexus789's picture

US versus Russia country kills - the US wins hands down since the end of WW2.

Stuck on Zero's picture

Russian AK47s have been the biggest killer of all weapons so far.

Zwelgje's picture

The US has killed three million people during the war against Viet Nam alone. AK's get nowhere close to this lone number.

But I shouldn't even reply because you perfectly know that AK's and its ammo are produced all over the world.

New_Meat's picture

"... But then Obama has failed at everything but killing brown people and defending the NSA/CIA infinte spying..."

You think that the other outcomes are NOT a part of O and his Masters' plans?

Silly child.

- Ned

ZD1's picture

"... But then Obama has failed at everything but killing brown people"

WTF? Who the hell are the brown people? If you are referring to Arabs, many of them are as light as Europeans.

The U.S. Census Bureau classifies "White" as a person having origins in any of the original peoples of Europe, the Middle East, or North Africa.



NoDebt's picture

Northern Europeans and points north = white people.  Brown people are everyone else in that group.  I'd even include Indians (with the dot, not with the feathers) as brown people.

If you think what I just said is racist you've completely missed the point.

Son of Captain Nemo's picture

And what fucking difference does another $2.5 trillion make after 8 "hardcore" years of printing?...

buzzsaw99's picture

yeah, if it's just a matter of clownbux the maggots don't have a problem

Bluntly Put's picture

Just guessing, but it seems to me the fed doesn't print currency directly, they issue credit, reserves at least in loans. I agree when they monetize debt like buying MBS they are essentially printing money, but what if they sold those assets?

So, some of their actions result in hot currency, while other actions are more related to the interdependent network of banks as capital flows related to interest and principle payments on outstanding loans/bonds/debt.

If all those channels get mucked up, then liquidity freezes and you get a credit crisis. If the fed actually just printed money it would retain it's value however much that value might drop over time and depreciation via debasement.

Son of Captain Nemo's picture

Good points BP

The problem is we know how derivatives laden those "assets" are, especially with respect to paper vs. physical in the COMEX.

Suffice it to say eventually the "Emperor" will default what is underneath the "kimono"...And when he does the ladies (shall we say) will be disappointed!

SheHunter's picture

Say it isn't true.  You mean to suggest the emperor has been going with the male measurement of 6 inches?

tmosley's picture

It's completely unsterilized and will get dumped directly on the economy.

New_Meat's picture

"Sterilize" is a term in the intervention realm that has not been brought  up in the modern regime.  Worth explaining if you would.



conscious being's picture

Money supply neutral. Twist was sterile.

Spiritof42's picture
Spiritof42 (not verified) Aug 29, 2015 5:18 PM

Looking forward to the day when gasoline is once again thirty cents a gallon.

Mister Ponzi's picture

The way the Fed is likely going to react house prices will rather be in the area of 10 trillion USD...

Latitude25's picture

Yes and that will be your monthly wage also.

Taint Boil's picture



A $1.00 silver eagle with a silver value of $14.60 per eagle.

$14.60 x 10,000 = $146,000.00


House are about 10,000 eagles now .....

Latitude25's picture

Now you're thinking right.  I want my next house for 1000 ASEs or better.

noguano's picture

I'm a Realtor in South Jersey and the market is extremely active for this time of year.   Outflow from stocks IMO.  Lot's of cash deals for single family, condos, and townhomes.  And rentors with really good credit buying and getting major concessions from sellers.  At this point it's better to buy than rent in my area of operation if you have good credit.  I sold a home to someone who brought $150 to the table and has a monthly payment of 1,500 compared to the 1,800 to 2,200 it would cost to rent.

Prices aren't as inflated at they were in 07' in my neck of the woods.  In fact just the opposite.  


SJ Realtor

Latitude25's picture

I'm in S FL and paid $70k cash for my house in 09.  Now it's supposedly worth $240k whereas in 06 it was worth $300k.  I'd say the bubble here has mostly reflated.  Lots of new construction also.  Looks ripe for another crash to me.

wrs1's picture

And employees with jobs make $2/hr

Taint Boil's picture



Three mercury dimes with a silver value of $1.05 per dime = $3.15 …… gas IS about 3 dimes per gallon.

wrs1's picture

I am paying $2.65 for premium and unleaded is going for $2.45.  By my math that is two and a half dimes which is about what gasoline was when I was a kid in the mid 60s.

TahoeBilly2012's picture

$2.45?? Where is that, Mobile AL? Come on up to Tahoe and get ur $3.49 out....

jerry_theking_lawler's picture

No, Mobile is down to $2.04...yesterday afternoon around 3pm'ish.

gizmotron's picture

That's about right. Oil is about 2.5x higher, today, than when oil was stable priced. But won't last. It costs more to extract oil (net, global) today than its current retail price. ha... Oil always returns to trend. Always. no exceptions. The question is: what is trend? I say $70-80, some say $100, others $60.

roadhazard's picture

I have paid .35 for a gallon of gas and my Father paid .11 and got a free set of dishes one time when I was nine or ten. Gas had lead and smelled wonderful.

falak pema's picture

well according to you then its 2 trillion larger than the shale unwind!

Saud is a bigger fish than shale especially if you throw the Chinese TNs unwind into the petrodollar pond!

When Pax Americana's ex surrogates on the Financial Titanic decide they need their OWN lifeboats !

Latitude25's picture

Yes.  Kill the dollar and blame it on China and other countries.  Seems like a plan.

Crash the stock markets and get the sheep into treasuries in 3....2....1

Got Au and Ag?

cherry picker's picture

Everything is so convoluted I don't understand it.  Maybe it is designed that way so main street can't see it.

I can understand shipping tonnages dropping, means less goods bought and sold.

I can understand selling oil at margins to kill off competition.

I can understand China selling Treasuries to either bolster their finances or to "pay' back the USA for 2008 and sticking their noses in the South China Sea.

I can understand tax revenues going down among other recession/depression indicators as people have no money, affecting business, labor markets and so on.

I don't understand at all how this 'reserve currency' stuff will play out and the above post really does not clarify it in my mind.


Latitude25's picture

AS an administration official told Kyle Bass a few years ago: "We're just going to kill the dollar".

Farqued Up's picture

The dumbasses are even having trouble killing the dollar.

RafterManFMJ's picture

... so easy, a Kenyan can do it.