Back in November we chronicled [23] the (quiet) death of the Petrodollar, the system that has buttressed USD hegemony for decades by ensuring that oil producers recycled their dollar proceeds into still more USD assets creating a very convenient (if your printing press mints dollars) self-fulfilling prophecy that has effectively underwritten the dollar’s reserve status in the post WWII era. Here’s what we said last year:
Two years ago, in hushed tones at first, then ever louder, the financial world began discussing that which shall never be discussed in polite company - the end of the system that according to many has framed and facilitated the US Dollar's reserve currency status: the Petrodollar, or the world in which oil export countries would recycle the dollars they received in exchange for their oil exports, by purchasing more USD-denominated assets, boosting the financial strength of the reserve currency, leading to even higher asset prices and even more USD-denominated purchases, and so forth, in a virtuous (especially if one held US-denominated assets and printed US currency) loop...
Few would have believed that the Petrodollar did indeed quietly die, although ironically, without much input from either Russia or China, and paradoxically, mostly as a result of the actions of none other than the Fed itself, with its strong dollar policy, and to a lesser extent Saudi Arabia too, which by glutting the world with crude, first intended to crush Putin, and subsequently, to take out the US crude cost-curve, may have Plaxico'ed both itself, and its closest Petrodollar trading partner, the US of A.
As Reuters reports, for the first time in almost two decades, energy-exporting countries are set to pull their "petrodollars" out of world markets this year.
[24]
Not long afterwards (and by that we mean “not long” in the sense that three months isn’t really that long when it comes to everyone catching on to what “fringe” bloggers say is likely important), Bank of America took notice in the form of interviews with a half dozen [25] or so in- house economists whose views can be generally summed up as follows: “...the end of the Petrodollar recycling chain is said to impact everything from Russian geopolitics, to global capital market liquidity, to safe-haven demand for Treasurys, to social tensions in developing nations, to the Fed's exit strategy.”
Here’s Goldman with a bit of color on the projected magnitude of the shifting Petrodollar dynamic:
We estimate that the new (lower) oil price equilibrium will reduce the supply of petrodollars by up to US$24 bn per month in the coming years, corresponding to around US$860 bn over the next three years. The ultimate impact, however, will depend on a number of key current account buffers (goods imports, net factor income and service imports).
Against this backdrop we bring you the following, from Bloomberg [26] which highlights the fact that oil producers are now liquidating their Petrodollar assets at a frenzied pace in the face of today’s “crude” realities:
In the heady days of the commodity boom, oil-rich nations accumulated billions of dollars in reserves they invested in U.S. debt and other securities. They also occasionally bought trophy assets, such as Manhattan skyscrapers, luxury homes in London or Paris Saint-Germain Football Club.
Now that oil prices have dropped by half to $50 a barrel, Saudi Arabia and other commodity-rich nations are fast drawing down those “petrodollar” reserves. Some nations, such as Angola, are burning through their savings at a record pace, removing a source of liquidity from global markets.
If oil and other commodity prices remain depressed, the trend will cut demand for everything from European government debt to U.S. real estate as producing nations seek to fill holes in their domestic budgets.
“This is the first time in 20 years that OPEC nations will be sucking liquidity out of the market rather than adding to it through investments,” said David Spegel, head of emerging markets sovereign credit research at BNP Paribas SA in London…
A concomitant drop in foreign reserves, revealed in data from national central banks and the IMF, is affecting nations from oil producer Oman to copper-rich Chile and cotton-growing Burkina Faso. Reserves are dropping faster than during the last commodity price plunge in 2008 and 2009.
The drawdown reverses a decade-long inflow into the coffers of commodity-rich nations which helped to increase funds available for investment and boost asset prices. Bond purchases have helped to keep interest rates low.
Oil producers recycled a large portion of their petrodollars -- a term coined for the dollar-denominated oil trade -- by buying sovereign debt of the U.S. and other countries. As they draw down reserves, Middle East countries are likely to sell “low-yielding European assets,” George Saravelos, strategist at Deutsche Bank AG, said in a note to clients.
Available data shows foreign savings by commodity-rich nations are dropping across the board. In Chile, the world’s top copper exporter, foreign savings fell $1.9 billion in February, the biggest drop in three years.
Analysts and officials anticipate that commodity-rich countries will continue selling off foreign assets through the year.
The IMF’s Arezki said that unless they cut spending, resources-rich nations “have no choice but to draw on their financial assets when available” as oil prices are well below the fiscal break-even needed by many exporting nations. The IMF estimates that many oil countries would only balance their budgets if crude prices recover to $75 or higher.
And so the liquidity drain is on, the only question is how far reaching the consequences will be and whether DM central bank largesse can effectively offset the implications of the petrodollar spigot being turned completely off for the first time in nearly two decades, representing a monumental fall from the more than $500 billion in EM Petrodollars that inundated the market just seven years ago. Here's an interesting take on this from Citi:
The longer crude prices persist at current levels, the more likely it is that these investors stop seeing inflows. And if that were to be the case, then the drop in crude prices could end up effectively offsetting further balance-sheet expansion from the BoJ and ECB.
Naysayers will argue that the two aren’t equivalent: QE is money creation while petrodollars are a zero-sum game. In other words, while petrodollars are being accumulated at a slower rate because crude prices have dropped, other economic actors are experiencing a corresponding windfall.
While that’s certainly the case, what matters is how the savings from lower crude oil prices end up getting invested relative to the investments made by sovereign wealth funds and FX reserve managers. And on that score, we suspect that petrodollar investors generally make conservative investments that are inherently fixed income-friendly, while the savings from lower gasoline prices tend to grow the top line revenue of consumer-oriented companies and the margins of those companies with significant transportation costs. As such, forsaken petrodollars rarely find their way back into fixed income markets.
In a very real sense then, we’d argue that the decline in petrodollar growth is likely to equate to less demand for fixed income securities and make the withdrawal of Fed QE that much more palpable.
* * *
As we said back in February, “...few actually grasped the implications of what plunging oil really means in a world in which this most financialized of commodities plays a massive role in both the global economy and capital markets, not to mention in geopolitics, with implications far, far greater than the amateurish ‘yes, but gas is now cheaper’ retort." In the end, the real question may be this: what happens socially and politically in EM oil producing states when, after years of depressed prices, the coffers finally run dry?
Here’s the schematic again:
[27]
