Posts Tagged ‘Guest Post’
Guest Post: The Coming Collapse Of The Petrodollar System
Monday, 20 May 2013 21:48
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Authored by Andrew McKillop,

PETRODOLLAR WAR

The theory of Petrodollar Warfare can be attributed to US analyst and author William R Clarke, and his 2005 book of that title which interpreted the US-UK decision to invade Iraq in 2003. He called this an “oil currency war”, but the concept of the petrodollar system and petrodollar recyling dates back to the eve of the first Oil Shock in 1973-1974. The role of the petrodollar system as a driving force of US foreign policy is explained by analysts and historians as basic to maintaining the dollar’s status as the world’s dominant reserve currency – and the currency in which oil is priced. (Read more…)

The term “petrodollar warfare” as used by William R. Clark says that major international war, legal or not, was seen as justified to protect the petrodollar system. Over and above the loss of human life, the combined costs of the Afghan and Iraq wars for the US are controversial like the interpretation of these wars as “oil wars”, but analysts like Joseph Stiglitz and Linda Bilmes put the total combined war cost at above $4 trillion. This can be compared with – and totally dwarfs – the annual cost of US oil imports, which are now sharply declining on a year-in year-out basis as domestic shale oil output ramps up, and US oil demand stagnates.

Clarke’s theory, like the explanation of the role and power of the “petrodollar system” depends on two basic drivers. Most major developed countries rely on oil imports, which are purchased using dollars, so they are forced to hold large stockpiles of dollars in order to continue importing oil. In turn this also creates consistent demand for dollars, and prevents the dollar from losing its relative international monetary value, regardless of what happens to the US economy.

 

Variants of the Petrodollar War concept include the role of oil currency conflicts and rivalry, notably concerning US relations with Iran, Venezuela and Russia, and possibly with Europe concerning the gradual replacement of US dollars with the euro, for oil transactions. More important, the entire petromoney system and the potential for Petrodollar War hinges on global oil import demand and the oil price. Both of these have to hold up. When or if they do not, foreign oil importer nations who formerly found it beneficial to hold dollars to pay for oil, would have to find some other (unexplained) reason for huge holdings of dollars, when their oil imports decline and-or oil prices also decline.

The “currency war” variant of the petrodollar system theory, holding that a shift to notably euros or gold for oil payments would undermine the system, is unrealistic when given any serious analysis, because all world moneys are interchangeable or convertible, and gold is priced in US dollars.

 

THE THREE PHASES OF THE SYSTEM

These are easy to define.

1974-1986 The first phase. The 1972 start of “petrodollar recycling” initiated by Nixon and Kissinger  just before the fivefold rise in oil prices of 1973-74, set the process of US-Saudi Arabian cooperation for the near-exclusive benefit of these two players. The US dollar was “backstopped” by the transfer of Saudi liquidities to the US Federal Reserve system banks, especially the Federal Reserve Bank of New York.  A small number of other chosen central banks, especially the Bank of England, and the central banks of Germany, France, Italy and Japan also benefitted.

1986-1999 The second phase. This also featured US and Saudi control, but under Clinton’s two mandates the focus radically changed to the controlled deflation or reduction of both oil prices and the world value of the US dollar. While the US continued to benefit from “petrodollar recycling”, Saudi Arabia was the major loser, undoubtedly changing its perceptions of the system’s utility to KSA.

2000-2013 The third and last phase. This period featured a major longterm rise in oil prices and the entry not in force, but progressively of the euro currency into the now enlarged “petromoney recycling” process. Euros now cover about 25% of global oil transactions, for an annual value of around €700 billion, with about the same amount of back-to-back additional lquidities. The massive growth of QE and central bank “easing”, from 2008, has heavily reduced the role of “petromoney recycling”.

Among the major changes of the petromoney system during these 3 phases, the first phase set the basic political concept among US deciders that “petrodollar recycling” could at one and the same time enable the US to run huge trade and budget deficits, low or very low interest rates, and prevent the collapse of the dollar’s value due to the forced need of all world buyers of oil to hold US dollars to make purchases of oil. By the second phase, this underlying concept shaded to including non-oil assets as the focus of value manipulation, controlled inflation and controlled deflation of value. In the third phase, massive increases of the oil price to 2008 played a major role in enabling the continued depreciation of the dollar’s world value as US sovereign debt also massively increased, but since 2008 and the start of central bank QE the need for, and role of the petrodollar system have heavily contracted.

 

THE SYSTEM IS NOW MENACED

Estimates of the exact size and role of petrodollars and petroeuros in the international money system, finance system, and economic system are varied. Many analysts however say the minimum role of the petrodollar system is to create, back-to-back, liquidities at least equivalent to the transaction value of the world oil trade, which for crude and products is about $3.4 trillion-a-year. Combined, the approximate minimum total $6.8 trillion annual value of oil trade plus the petromoney system is about 10% of world annual GNP, equivalent to about 45% of US annual GDP. This may appear as still large and important but has to be compared with, for example, the exposure of national private banks only in Europe in relation to national GDPs, which is often 300% – 400%.

Only QE can “plaster over” these liabilities.

Petromoney recycling is still treated by “the elites” as a critical prop to monetary system integrity, and explains why the USA is far from the only country depending on the system holding up. All oil producers, even smaller-sized, are beneficiaries the same way as all major developed nations’ central banks, but the US is still the prime beneficiary. However, the basic supports for the system’s operation – continuing high oil demand, high oil prices, and oil priced in dollars -  have all weakened or are threatened, today. In particular when global oil demand declines or stagnates, and when oil prices decline, the dollars that will no longer be needed for global purchases of oil will return in massive amounts back to their country of origin, the USA. The consequences can only be dramatic, and threaten the start of a process completely unlike the Clinton-era controlled devaluation of the dollar’s value along with the decline of oil prices consented by Saudi Arabia.

The now-menaced “petrodollar system” is also weakened because of worldwide change in the perception of oil and oil energy. From the dawn of the petroleum age to its accelerating twilight, today, geopolitical strategies concocted by developed nations featured the maintenance of secured access to world oil supplies. This was believed to be a win-win strategy for developed nation policy makers, and especially for US policy makers. From the 1970s and the first Oil Shock of 1973-1974, the only “morph’ in this policy and strategy was to substitute expensive oil, for cheap oil.

For the USA’s ability to run deficits and the petrodollar system, much higher oil prices were a major gain, not a loss, and this is almost surely still the perception of the Obama administration today.

In its first phase and last phase, the economic and political incentives for ensuring national access to oil supplies, and the existence of the petrodollar system as a monetary and finance tool – unrelated to the economy – worked better with higher oil prices. Today however, with the major and massive changes of oil resource availability revealed by the shale energy revolution, rising global oil production capabilities, stagnating oil demand, and rising renewable energy supplies in all major developed countries, and the constantly declining role of oil in the economy, the Petrodollar System’s days are surely numbered, like the notion that $100-oil prices are “normal”.

The impact of this will be massive.

    



 
Guest Post: Another Episode In The History Of Failed Manipulations
Monday, 20 May 2013 18:40
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Submitted by Martin Sibileau of A View from the Trenches blog,

“…The Argentine government jawboned the foreign exchange market more efficiently than Draghi did with the gold market upon the insinuation that Cyprus would sell its gold…”

I am back from a brief trip to Argentina’s Patagonia, where I could confirm first-hand the irreversible damage caused by interventionist policies: Widespread poverty, abandoned infrastructure, scarcity of consumer goods, unseen unemployment and criminality, etc. I could also see for myself the madness of hedging against inflation with the purchase of new cars. The streets of any forgotten small town in Patagonia are filled with brand new 4×4 vehicles that would be the envy of many in North America. (Read more…)

While visiting too, the Argentine government made a new move to suppress the price of the physical US dollar. In previous articles (here and here), I made the case that the broken US dollar market in Argentina would provide insights into what we may eventually expect from the gold market, if it broke in the same fashion. However, I had underestimated the magnitude of the USD physical market. Zerohedge brought attention to this point a few days ago (here).

Overview

In August of 2011, Argentina’s government slowly began to implement a series of actions destined to curtail the right of citizens to access US dollars (foreign exchange in general). The goal was and is to force savings into pesos, as pesos are after the taxable asset in a country that cannot access capital markets and fully monetizes its deficits.

From that moment onward  physical US dollars started to trade at a premium. Last week, with the paper US dollar value at 5.11 pesos, that premium was over 100%. Physical US dollars, i.e. dollars outside the system, reached a bid/ask of 10.30/10.45 pesos. The chart below should help visualize this dynamic (source: Reuters/La Nación)

May 20 2013 1

The latest move: Tax moratorium to repatriate capital

With a 100% premium over the “official” price of the US dollar, on May 7th, the federal government announced a moratorium for off-shore capital (see here, in Spanish). A simple reading of this measure would reveal a government encouraging capital inflows to an investments-starving nation. The moratorium, after all, is for capital directed to the real estate and energy sectors. The real intention behind it is, however, to narrow the gap between the official and black market price of the US dollar, via manipulation of the “official” price, as I will show further below. At the official price, of course, one finds no sellers.

The moratorium is a tax pardon, no questions asked, for all Argentines who decide to bring onshore their undeclared US dollars deposited offshore. Although it is not clear yet whether the declared funds can be freely disposed of, the government seeks that they be applied to the purchase 2016 4% bonds issued by the federal government or USD certificates, issued by the central bank. These USD denominated certificates (see image below, source: La Nacion) are to be used to clear transactions in the real estate sector, are fully endorsable and have no maturity. In other words, the government wants to further segment the US dollar market.

May 20 2013 2

I can’t help speculating that years into the future, one would see a developed country implementing a similar measure to repatriate undeclared gold.

How it works

The tax moratorium is a simple transaction. Let’s forget about the USD certificates issued by the central bank that pay no interest and assume that the public will accept them like US dollars. We are talking about a public that already holds 1 every 15 US dollar bills in the world. My view is that these will not prosper, because I doubt that anyone selling real estate would be willing to take them at face value.

We are left with the 4% coupon bonds issued by the federal government, maturing in 2016, which are bought by offshore depositors. The figure below shows the accounting:

May 20 2013 3

 

 

Final Observations

By now it should be clear that if the Argentine government had only wanted to attract offshore capital to fund investments, there would have been no need to have the Government Issue interest paying certificates.

It is also obvious that for this policy to be successful, offshore depositors must believe that declared, taxable, interest paying USD certificates are better than holding US dollars off-shore. But if these certificates are to be liquid, the discount in the secondary market should be lower than 12% approximately, in the absence of counterparty risk (4% x 3 years). And with the Federal Government of Argentina as the issuer, there is no doubt that counterparty risk is real and present. Preliminarily the government expects $4 billion to be declared.

One would find this measure laughable, as it is absolutely evident that one is better off holding undeclared funds offshore than facing scrutiny to earn a 4% interest on a certificate issued by the government of a country that defaulted on its debt and has no access to the capital markets.  Yet, in this new normal world we live in, with the announcement, the price of the US dollar fell to 8.87 pesos, which represents a considerable 13.9% drop. To put the reaction in perspective, the Argentine government jawboned the foreign exchange market more efficiently than Draghi did with the gold market upon the insinuation that Cyprus would sell its gold.

It is also a known fact that financial repression in Argentina is a publicly disclosed policy, and some may attribute the drop to the same. But I cannot deny that the reaction surprised me. If the measure is successful, would the success indicate that monies currently offshore are perceived to be in far greater danger than in a country where they can be laundered into the energy sector? To finance a company that was confiscated in 2012 to the Spanish crown?

Regardless of the initial drop (the closing price on Friday May 17th was 8.95 pesos, while the official price was 5.25 pesos), one wonders if the Argentine government can sustainably manipulate the price of the US dollar, assuming the certificates are accepted in the market, and if there are lessons to be learned here.

Without changing the terms of the tax moratorium, Argentina’s government could replicate the tactics of the gold cartel to suppress the price of the US dollar. The way to achieve this is by expanding the credit multiplier, as shown below:

May 20 2013 4

The figure above shows that with the US Dollars repatriated and in the balance sheet of the Federal Government (assets), it could be possible, assuming that the certificates are accepted, to generate a credit pyramid in the system. If the certificates are accepted in deposit by banks (step 2 above), these can use them to expand their USD loan base (just like bullion banks use the gold ETFs to expand their gold loans).

This scheme would suppress the price of the US dollar (just like gold loans suppress the price of gold), in a country where depositors have not lost their deposits to their banks (i.e. in a country where people trust their banks). But we all know this is not the case with Argentina. However, I can imagine that the 4% coupon of the certificates will not carved in stone. Would a 20% interest on USD certificates encourage certificate holders to leave them in deposit? It did in 2001, and with Argentina’s holdouts still alive and fighting, this alternative scheme would allow the government to source US dollars and keep kicking the can until the next election.

Nevertheless, with an ever increasing fiscal deficit, it would take an equally growing amount of leverage (on the bonds) to keep the party going. But remember: This whole intellectual exercise is based on the assumption that the bonds trade in the secondary market and that one can only produce a tax moratorium every few years….

If the “bancos” had to offer a high interest rate to use the bonds as collateral (say, above 20% or most likely above the actual inflation rate), the Banco Central (i.e. not the Federal Government that issues the 4% bonds) would feel tempted to directly subsidize the banks, while earning a laughable amount, from its US dollar bills. This subsidy would be required to maintain a positive net interest margin, because I doubt that the bancos would be able to make any significant USD loans at such rates. There is a precedent to this in the Cuenta de Regulación Monetaria, established in 1977.

We can now see that the sustainability of the manipulation in a segmented/broken foreign exchange market causes a negative carry, which would create a quasi-fiscal deficit in Argentina (i.e. the deficit of the Banco Central), fully opening the gates to hyperinflation. I have made the point in earlier letters (here) that the same could be conceived to happen with the manipulation in the price of gold. This latest example from Argentina serves therefore as another experiment in the history of failed manipulations.

One last comment: Because the scheme is so visibly unsustainable, the temporary drop in the price of US dollar bills (i.e. physical US dollars) will attract a higher demand of said US dollar bills, forcing the leverage provided by the certificates to grow exponentially. In the week of the announcement, USD deposits fell another 96 million. This is the same behaviour seen in physical gold.

What makes the gold market of 2013 different?

As gold is a commodity, there is no counterparty risk: Either the gold is or isn’t where it is supposed to be. This makes the gold market less flexible than, say the foreign exchange market just described above. Why? There cannot be an interest rate in gold paper that will keep investors in the Ponzi scheme, just like there is one for US dollar bonds in Argentina.

For instance, if a gold ETF (or any commodity ETF for this purpose) offered a coupon, it would raise all kinds of suspicions, unless we are in a system where gold is allowed to compete with legal tender, in which case too, there would not be a need for gold ETFs. This means that in order to keep its price suppressed, the gold market requires outright fraud. It also means that the only way that such fraud can be resolved is with plain and swift confiscation, because once revealed, no interest rate will clear the market.

If it is correct, as reported, that 1 out of every 15 US dollar bills is held by an Argentine, it is easy to see why the retail US dollar investor in Argentina managed to break the market and keep the official manipulation at bay. This is not the case with the global gold market today, but it was certainly not the case in Argentina of the ‘70s either, when the decline of its economy began to show itself as evident.

    



 
Guest Post: The New Abnormal
Monday, 20 May 2013 11:50
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Submitted by James Howard Kunstler of Kunstler.com,

The collective state of mind in the USA these days may be even more peculiar than what went on in Germany in the early 1930s, when the Nazis were freely elected to lead the country and reconstructed the battered national psyche into a superman cult that soon beat a path to mass death and ruin. America has its own way of going crazy. We don’t goose-step to tragedy; we coalesce into an insane clown posse and stumble into it by pratfall — juggaloes dancing backwards off the cliff edge. (Read more…) 

We’ve been softened up and made extra-stupid on a 60-year-long diet of TV and kreme-filled donuts.  Instead of a “master race,” our political fantasies revolve around a master wish – to get something for nothing. Want to feel good about yourself? Smoke some crank. Want to become economically secure? Buy a Powerball ticket or drive to the local casino. Want political esteem? Plug a flag pin into your lapel. Want status? Borrow free money from the Federal Reserve at zero interest and arbitrage it into massive earnings for your primary dealer bank. All these behaviors are the consequence of a culture that elevated advertising to such a high social good, it ended up drowning in its own manufactured bullshit.
 
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A subset of our master wish has been on vivid display in recent months, namely the idea that God has blessed the USA with a limitless supply of new oil that will allow us to keep driving to WalMart forever. This propaganda from an oil industry desperate for capital investment has been swallowed whole by people in authority who ought to know better, just as that same class of people in Germany of 1934 should have known better about what they were bargaining for in economic well-being with the Nazi agenda. In our case, the propaganda drumbeat is being led by formerly respectable news organizations. The New York Times, National Public Radio, Bloomberg News, Forbes, and The Atlantic Magazine are media giants that have lately spread the “good news” that America will soon be 1) “energy independent,” 2) the world’s leading oil exporter (greater than Saudi Arabia is now!), and the “go-to nation” for cheap manufacturing.
All of these claims are false, by the way. The American way-of-life was designed to run on $20-a-barrel oil, not $90-a-barrel oil, and “new technology” has not changed that. The unfortunate and, to some extent, mendacious memes about the wonders of “new technology” have only snookered the public into a false sense of security about a future that will disappoint them badly and probably provoke an extreme political reaction as the reality of our predicament sweeps through daily life.
Most of the current “endless oil” fantasy revolves around shale oil. Just to get a visual idea of what this amounts to, consider this map. It depicts the two major shale oil production regions of the USA: the Bakken in North Dakota and the Eagle Ford “play” in Texas. Bakken production is confined almost entirely to four counties in North Dakota (Williams, Mountrail, McKenzie, Dunn). The Eagle Ford region touches perhaps ten Texas counties. Now, realize that the oil fields all over the rest of the USA (including Alaska) are in decline. Here’s where the “bonanza” of new oil all comes from:
 
Shale.jpg
The oil coming out of these places is high cost and low flow-rate oil. This is exactly the opposite of what US oil production used to be (low cost and high flow-rate) when we were busy building all the freeways, strip malls, housing subdivisions, suburban office parks and all of the other stranded assets that now make up the infrastructure of daily life in this country. Those were the days when you could pound a single pipe vertically 1000 feet down (not much deeper than many home water wells) into the temperate wheatfields of Oklahoma (drive to work in shirtsleeve weather!) and after that modest investment in drilling you could kick back and depend on a great flow rate (5,000 barrels-a-day, not unusual) of sweet light petroleum for years.
Horizontal drilling (often more than 10,000 feet down + many “laterals” an additional 10,000 feet horizontally) and then fracturing “tight” rock for shale oil is not only a way larger capital expense (lots of steel!) but the flow rates per well (82 barrels-a-day average) are laughable compared to the halcyon days of conventional oil — little better than “stripper” wells. Consider also that shale oil well flow-rates decline greater than 60 percent in the first year (rapidly thereafter, too) and you can see easily that there will be no “kicking back” to run the pump-jacks like cash registers, as in the old days. In fact, the rapid depletion only prompts more frantic drilling and re-drilling to keep the production at its current rate – the “Red Queen Syndrome” (“I’m running as fast as I can to stay where I am”), which means fantastic capital expenditure to keep drilling and fracking more wells (even more steel!). Consider also, that the small “sweet spots” in the shale oil regions were the ones drilled first (in earnest after 2003), for the simple reason that they were the most promising. This was the “low hanging fruit” — easy to pick. Outside these sweet spots the oil may be too meager or difficult or costly to bother drilling for.
This is a picture of a boomlet that may run a few more years — if the banking system doesn’t implode and the massive stream of capital doesn’t quit flowing to the shale counties. The excitement will all be over before 2020, but I suspect that troubles in finance and banking will put the schnitz on the shale gas mania long before that date. What will happen when the American public discovers that they were lied to about yet another important matter? The discovery will coincide with very severe changes in daily life that won’t be avoidable. Everyone will be affected. Many will be impoverished and suffer real hardship. That’s when the public goes apeshit and starts tearing down the house.
Apart from the issue of sheer economic suffering and all the damage that will ensue, consider that it will be generations before anyone believes the “authorities” again — though, like the oil age itself, the era of giant national media will probably prove to be a one-shot deal, too. Future generations — if they are lucky — may read the news on one-page circulating broadsides, printed laboriously in hand-set type by letterpress. Or maybe they’ll be reduced to just parsing out rumors.