KW: Another couple of articles from Jim Rickards pen helping you to understand some of the pressures going on in financial markets
I. Another Nation is Pricing Oil in Yuan. The Petrodollar is Slowly Dying
Most readers are familiar with the original petrodollar deal. It was set up by Henry Kissinger and Saudi princes in 1974 to prop up the U.S. dollar. At the time, confidence in the dollar was on shaky ground because President Nixon had ended gold convertibility of dollars in 1971. Saudi Arabia was receiving dollars for their oil shipments, but they could no longer convert the dollars to gold at a guaranteed price directly with the U.S. Treasury. The Saudis were secretly dumping dollars and buying gold on the London market. This was putting pressure on the bullion banks receiving the dollar. Confidence in the dollar began to crack. Henry Kissinger and Treasury Secretary William Simon worked out a plan. If the Saudis would price oil in dollars, U.S. banks would hold the dollar deposits for the Saudis. These dollars would be “recycled” to developing economy borrowers, who in turn would buy manufactured goods from the U.S. and Europe. This would help the global economy and help the U.S. maintain price stability. The Saudis would get more customers and a stable dollar, and the U.S. would force the world to accept dollars because everyone would need the dollars to buy oil. Behind this “deal” was a not so subtle threat to invade Saudi Arabia and take the oil by force. I personally discussed these invasion plans in the White House with Kissinger’s deputy, Helmut Sonnenfeldt, at the time. The petrodollar plan worked brilliantly and the invasion never happened. Now, 43 years later, the wheels are coming off. The world is losing confidence in the dollar again. China just announced that any oil-exporter that accepts yuan for oil can convert the oil to gold on the Shanghai Gold Exchange and hedge the hard currency value of the gold on the Shanghai Futures Exchange. This straight-through processing of oil-to-yuan-to-gold eliminates the role of the dollar. Russia was the first country to agree to accept yuan. This article reports that Venezuela has also now signed on to the plan. Russia is #2 and Venezuela is #7 on the list of the ten largest oil exporters in the world. Others will follow quickly. The end of the petrodollar and of U.S. dollar hegemony is upon us.
II. U.S. Dollar Hegemony is Experiencing the “Death of a Thousand Cuts”
Leading reserve currencies do die but not necessarily overnight. The process can persist over many years. For example, the U.S. dollar replaced the UK pound sterling as the leading reserve currency in the 20th century. That process was completed at the Bretton Woods conference in 1944, but it began thirty years earlier in 1914 at the outbreak of World War I. That’s when gold began to flow from the UK to New York to pay for badly needed war materials and agricultural exports. The UK also took massive loans from New York bankers organized by Jack Morgan, head of the Morgan bank at the time. The 1920s and 1930s witnessed a long, slow decline in sterling as it devalued against gold in 1931, and devalued again against the dollar in 1936. The dollar is losing its leading reserve currency status now, but there’s no single announcement or crucial event, just a long, slow process of marginalization. The article above showed how Venezuela is now pricing oil in yuan instead of dollars. This article reports that Russia has now banned dollar payments at its seaports. Although these seaport facilities are mostly state-owned, many payments, like those for fuel and tariffs, were still conducted in dollars. Not any more. This is just one of many stories from around the world showing how the dollar is being pushed out of international trade and payments to be replaced by yuan, rubles, euros or gold. Eventually a tipping point will be reached where the dollar collapse suddenly accelerates as happened to sterling in 1931. Investors should acquire gold and other hard assets before that happens.
III. Wall Street Experts Still Don’t Understand the Fed. Here’s the Real Story
On Wednesday, September 20, the Federal Reserve announced that they were leaving interest rates unchanged. That came as no surprise. The Fed also announced they were beginning their program of reducing their balance sheet and reducing the money supply in October. This is what we call “quantitative tightening” or QT, and it also came as no surprise. Both moves had been signaled well in advance by the Fed, and we told readers as long ago as last March that the Fed would hike rates in June and then stand pat in September. That’s exactly what happened. What did surprise the markets was the hawkish tone struck by the Federal Open Market Committee, FOMC, members made up of the Fed Board of Governors and certain regional Federal Reserve Bank Presidents. Their projections show one more rate hike in December and three in 2018. These projections are made by putting dots on a plot of rates and dates, the so-called “dot plot.” Wall Street analysts and mainstream media focused obsessively on the dots like ancient seers sifting through the entrails of a slaughtered goat. As a result of the hawkish tone revealed by the dots, the dollar strengthened, and euros, gold and Treasury notes sold off. The only problem with this analysis is that is has nothing to do with reality or with how the Fed actually decides policy. The dots are meaningless and are regarded as a joke around Fed headquarters in Washington. As this article shows, prior periods of Fed tightening have resulted in lower rates because the tightening caused disinflation. Prior periods of Fed ease resulted in higher interest rates as markets braced for inflation and a weaker dollar. Both moves are the opposite of what the gurus are projecting. It’s likely the gurus are wrong and intermediate-term rates will actually decline as the Fed tightens. The dots play no role in policy whatsoever. Here’s a model that does work: The Fed is on track to raise rates every March, June, September and December unless one of several “pause” factors applies. Right now, the pause factor of disinflation does apply. The Fed’s main inflation metric has been declining steeply all year and is now a half-percentage point lower than it was last January. Until that reverses, and it won’t be soon, the Fed is on hold. In analyzing the Fed, it’s critical to use the right model and look at the right evidence. While the mainstream media chases dots, we’re tightly focused on the Fed’s preferred inflation metric coming out September 29. That will tell us far more than a plot full of dots.
IV. Wall Street Created a Single Point of Failure. Let’s Hope It Doesn’t Fail
A system is composed of many linked components, which interact with each other and act together to produce the result desired by the system designer. Often a system is robust, which means than one or more components can fail but the system as a whole survives. An engineer’s worst nightmare is what is called a “single point of failure.” This arises when a large system relies entirely on one component. If that component fails, the entire system fails. Think of an ice climber going straight up a frozen waterfall several hundred feet in the air. The climber relies on a system or ropes, ice-screws, carabiners (a type of clip), a climbing harness, an ice axe and other tools. The rope is a single point of failure. If it breaks, the climber can fall to death or serious injury even if the other parts of the system are working fine. Climbers are fanatical about checking, and rechecking every piece of equipment to make sure this does not happen; I’ve done ice climbing so I understand the problem first hand. Wall Street has just created a gigantic single point of failure in the largest and most important securities market in the world — the U.S. Treasury market. When dealers or customers buy Treasury securities, they typically finance them by pledging the security for cash used to pay for the purchase. These secured loans, called “repos,” are often rolled-over every day even for securities with maturities of five or ten years. Securities pledged to one party can be re-pledged over-and-over. The repo market is massive and highly leveraged. It is the beating heart of global capital markets, much bigger than any stock exchange. As this article reports, the repo market is down to one and only one clearing bank — Bank of New York Mellon, BONY. The one other bank that had been in the repo clearing business, JPMorgan, just withdrew. If BONY’s systems fail, the entire Treasury market will fail, and every other stock, forex and bond market will not be far behind. BONY almost did fail on 9/11. It was one block from the Twin Towers. One of the first acts of the first responders at Ground Zero was to run emergency power to BONY to help get the Treasury market up and running again. At least on 9/11 JPMorgan was around as a back-up (all banks and exchanges were closed for a few days anyway). Today, BONY is a single point of failure for global capital markets. Let’s hope it doesn’t fail. And it’s a good idea to own some physical gold in case it does.
V. Ice Nine Has Already Visited Greece and Cyprus. Now it Comes to Spain
Ice-Nine is a concept created by Kurt Vonnegut in his 1963 novel Cat’s Cradle, which I borrowed for use in my latest book, The Road to Ruin. In Cat’s Cradle, Ice-Nine is a molecule similar to water with two differences. Ice-Nine has a melting point of 114.4º F (which means it’s frozen at room temperature) and when a molecule of ice-nine comes in contact with a molecule of water, the water turns to ice-nine and freezes. Vonnegut’s plot used ice-nine as a doomsday machine. A single molecule of ice-nine released from a vial could eventually freeze all the water on earth and all life on the planet would die. In my book, ice-nine was a metaphor for the freezing of the financial system. In the next financial panic, money market funds have the right to freeze redemptions (that was not true in 2008 and the Fed had to guarantee them to prevent systemic collapse). Once money market funds are frozen, clients desperate for cash will run to the banks. Tthen bank accounts will have to be frozen also, and so on until the entire financial system is frozen to stop the panic. Scenarios like this have played out in Cyprus in 2013 and Greece in 2015. At one point in 2015, the Greek system was so locked down that citizens flew to Germany and flew home with suitcases full of euros so they could have money to spend because there was no money available in Greece. Now it’s Spain’s turn for ice-nine, but for a different reason. As this article shows, the Madrid government has frozen the accounts of the Catalonian regional government to prevent Catalonia from holding an independence referendum. This action along with the prior crises, reveals that your money in the bank is not really yours, it’s the bank’s. Whoever controls the bank, usually a government, controls your money, not you. If you want control of your money you need to convert some of it to physical gold. That way it can’t be frozen or digitally hacked. By the way, since gold is a metal in solid form it’s technically “frozen” at room temperature — just like ice-nine. The difference with gold is that you’re in control.