The Cardinal Sin of International Finance
As Doug Casey has correctly noted, the prime directive of any organism—whether it’s an amoeba or a person or a corporation or a government—is to survive.
That’s why the US government protects the petrodollar so zealously. It needs the system to survive.
World leaders who have challenged the petrodollar recently have ended up dead…
Why Everyone Uses the US Dollar… for Now
In the 1970s, the US government struck a series of deals with Saudi Arabia, creating the petrodollar system. The US promised to coddle and protect the Saudi kingdom. And, in exchange, Saudi Arabia would use its dominant position in OPEC to ensure that all oil transactions happened in US dollars.
Until recently, virtually anyone who wanted to import oil from any country needed US dollars to pay for it.
The dollar is just a middleman here. But countries and businesses use it in countless transactions amounting to trillions of dollars that have nothing to do with US products or services.
Plus, if foreign countries are already using dollars for oil, it’s just easier to use the dollar for other international trade. That’s why, in addition to oil sales, the US dollar is used for about 80% of all international transactions.
Take Saddam Hussein and Muammar Gaddafi, for example. Each led a large oil-producing country—Iraq and Libya, respectively. And both tried to sell their oil for something other than US dollars, before US military interventions led to their deaths.
In October 2000, Saddam had started to sell Iraqi oil for euros only. Iraq said it would no longer accept dollars for oil because it did not want to deal “in the currency of the enemy.”
A little over two years later, the US invaded. Immediately after Baghdad fell to US forces, all Iraqi oil sales were switched back to dollars.
Thanks to WikiLeaks’ release of Hillary Clinton’s emails, we know that protecting the petrodollar—not humanitarian concerns—was a primary reason for overthrowing Libya’s Gaddafi.
According to her leaked emails, the US (and France) feared that Gaddafi would use Libya’s vast gold reserves to back a pan-African currency. This gold-backed currency would have been used to buy and sell oil in global markets. Also, it would have likely displaced a version of the French franc that’s used in Central and Western Africa.
The US and France backed a rebellion, both militarily and financially, that overthrew Gaddafi in 2011.
After Gaddafi’s death, plans for the gold-backed currency—along with Libya’s 4.6 million ounces of gold—vanished.
Of course there were other reasons the US toppled Saddam and Gaddafi. But protecting the petrodollar was a serious consideration, at the very least.
Putin Is a Tougher Adversary
The dollar’s special status gives Uncle Sam tremendous leverage. So it’s no surprise that Russia wants to undermine the petrodollar system.
Russian President Vladimir Putin summed it up this way:
Russia shares the BRICS countries’ concerns over the unfairness of the global financial and economic architecture, which does not give due regard to the growing weight of the emerging economies. We are ready to work together with our partners to promote international financial regulation reforms and to overcome the excessive domination of the limited number of reserve currencies.
Essentially, Putin is saying they all want to ditch the dollar.
That’s largely because the US uses the dollar as a political weapon. For example, the US tried to sanction Russia for its actions in Crimea and Ukraine. These sanctions made it harder for Russia to access the US dollar–based financial system. So of course Russia is going to push for an alternative.
Shortly after the sanctions, Russia struck a massive deal to sell oil and gas to China for yuan. The deal totally bypassed the US financial system… and any sanctions.
China’s Permanent Bypass Around the US Dollar
Russia is the world’s largest energy producer. China is the world’s largest energy importer. Normally, they would trade with each other exclusively in US dollars.
But, as I’ve told you in recent weeks, China is now introducing a more permanent way around that.
I call it China’s “Golden Alternative” to the petrodollar. It’s a streamlined way for Russia and everyone else to sell oil to China for yuan—or effectively gold.
China’s “Golden Alternative” to the Petrodollar
China is launching a practical and attractive alternative to the petrodollar system. It will allow anyone in the world to trade oil for gold. It will also totally bypass the US dollar.
Here’s how it will work…
The Shanghai International Energy Exchange (INE) is introducing a crude oil futures contract denominated in Chinese yuan. It will allow oil producers to sell their oil for yuan.
Of course, China knows most oil producers don’t want a large reserve of yuan. So producers will be able to efficiently convert it into physical gold through gold exchanges in Shanghai and Hong Kong.
Bottom line, two of the biggest players in the global energy market are totally bypassing the petrodollar system.
Informed observers say Russia is already converting a large portion of its yuan earnings to gold.
Of course, other countries are interested in sidestepping the US financial system and US sanctions, too. China’s Golden Alternative will give anyone the option to do just that.
This will make the US dollar a much less effective political weapon.
Other countries on Washington’s naughty list are enthusiastically signing up. Iran, another major oil producer, is accepting yuan as payment. So is Venezuela, which has the world’s largest oil reserves.
I think others will soon follow. From the perspective of an oil producer, it’s a no-brainer.
With China’s Golden Alternative, an oil producer can participate in the world’s largest market and try to capture more market share. It can also easily convert and repatriate its proceeds into gold, an international form of money with no political risk.
But this doesn’t apply to one critical holdout… Saudi Arabia.
Twisting the Saudis’ Arm
Saudi Arabia is the world’s largest oil exporter. A lot of that oil goes to China, the world’s largest importer.
Beijing still reluctantly pays for Saudi crude in US dollars. The Saudis won’t have it any other way, at least for now.
This bothers China. It can only import Saudi crude by obtaining and then using US dollars. And that, of course, means it has to stay in Washington’s good graces.
Trump’s Treasury secretary really drove this point home recently. He threatened to kick China out of the US dollar system if it didn’t crack down on North Korea.
China would rather not depend on an adversary like this. This is one of the main reasons it’s launching the Golden Alternative.
Saudi Arabia, however, refuses to participate. It won’t sell its oil in anything but US dollars because that would break its longstanding petrodollar agreement with the US.
When China, Russia, and others trade oil for yuan, it’s a significant blow to the petrodollar. But if Saudi Arabia switched to yuan, it would take out the petrodollar… and cause an immediate financial panic in the US.
The truth is selling oil for yuan would cost Saudi Arabia a whole lot.
It would immediately lose American diplomatic and military protection. Then the media and think tanks would quickly start pounding the table for the US military to force democracy on Riyadh.
Last year Trump said, “If Saudi Arabia was without the cloak of American protection, I don’t think it would be around.”
He’s absolutely correct.
Of course, the Saudis know all of this. So they’ve been on a short leash… until recently.
In a surprise move, Saudi King Salman recently became the first sitting Saudi monarch to ever visit Russia.
Until recently, the visit would have been unthinkable. Saudi Arabia has been one of the US’ closest allies since the petrodollar system started in the 1970s.
Meanwhile, Russia and Saudi Arabia have been enemies for decades. Most recently, the Saudis and Russians have been on opposite sides of the Syrian Civil War.
That’s why King Salman’s historic visit to Moscow is so remarkable. The Saudis are clearly hedging their bets against the US and the petrodollar system.
Saudi Arabia is now drifting closer to Russia.
The Saudis have committed to invest up to $10 billion in various Russian sectors. But, even more significantly, they’ve agreed to buy the S-400 missile system, Russia’s top line air defense system, as part of a $3 billion weapons purchase.
This deal signals a geopolitical earthquake. The Saudis have never bought Russian military equipment before.
Ever since the birth of the petrodollar, the Saudis have depended on American military protection. After all, it’s what they get in return for pricing their oil in dollars.
The S-400 system deal suggests the Saudis are hedging their bets. First, they’re not buying an American system. Second, they’re buying a Russian system that’s capable of deterring an American attack.
Saudi Arabia is making significant moves to give itself alternatives to American protection.
At the same time, China is cutting back on Saudi crude.
A few years ago, Saudi oil made up over 25% of Chinese oil imports. They were Beijing’s No. 1 supplier. Today, the Saudis’ market share has dropped below 15%.
In other words, the Saudis are losing massive market share and getting pushed out of the biggest oil market in the world. This is mainly because they refuse to sell oil to China in yuan.
China has made itself clear. It’s willing to expand business with anyone who will accept yuan as payment.
Today, Russia has overtaken Saudi Arabia as China’s top supplier. Its share of the lucrative Chinese market has grown from 5% to over 15%.
Russia’s enthusiastic acceptance of yuan as payment is the main reason for this shift.
In the meantime, Angola, an African oil producer, has also come on board. The country now accepts yuan as payment for its oil exports to China. It even made the Chinese yuan its second legal currency in 2015.
Chinese imports from Angola have shot up since. It’s now China’s No. 2 supplier, after Russia.
None of this bodes well for the petrodollar system.
The Saudis have two choices… rip up the petrodollar or get shut out of the world’s most lucrative oil market.
One way or another—and probably soon—the Chinese will find a way to compel the Saudis to accept yuan. The sheer size of the Chinese market makes it impossible for Saudi Arabia to ignore China’s demands indefinitely.
What to Watch For…
China might not convince the Saudis to ditch the petrodollar system tomorrow. But it’s making significant progress.
A few months ago, Saudi Arabia announced it was willing to issue Panda bonds to finance its government spending deficit. (Panda bonds are yuan-denominated bonds from non-Chinese issuers that are sold in China.)
This is remarkable. The Saudis’ currency is pegged to the US dollar. Up until this point, they’ve exclusively used US dollars for all of their major financial initiatives.
Issuing debt in yuan—instead of US dollars—is a significant move. It means Saudi Arabia is drifting closer to China.
Also, the Saudis recently inaugurated the massive Yasref refinery in the Saudi city of Yanbu. The refinery is an $8.5 billion joint venture between Saudi Aramco and China’s Sinopec.
These are noticeable steps. But the Saudis still haven’t given China what it really wants—oil for yuan.
However, it could happen soon…
The Largest IPO in History
In the coming months, the Saudis plan to float a 5% stake in Saudi Aramco, the state oil company.
Saudi Aramco is the most valuable company in the world. It will likely be the biggest equity offering ever. It could triple, or even quadruple, Alibaba’s current record initial public offering (IPO) of $25 billion.
The IPO’s success will depend on Saudi Arabia recruiting big cornerstone investors. But so far, Western investors haven’t shown a lot of enthusiasm.
For China, however, it could be the perfect opportunity to buy political influence in Saudi Arabia.
If China bought a large stake in the Aramco IPO, it would help cement its relationship with Saudi Arabia. It would also put more distance between the Saudis and the Americans.
And critically, it would give the Chinese more leverage to compel the Saudis to accept yuan for oil.
China is in the process of negotiating not just a 5% stake, but potentially a larger one.
Bottom line…the Saudis haven’t made a clean break with the US yet. However, they are drifting toward China financially and Russia militarily.
The Saudis are clearly setting up the option to dump the petrodollar.
If the Saudis sell oil to China in yuan, it would kill the petrodollar overnight. However, short of that, things still look very dire for the petrodollar.
The petrodollar system is facing serious erosion, thanks in large part to China’s Golden Alternative. That’s already baked into the cake.
And with that, severe inflation in the US is a certainty.
This will likely be the tipping point…
After the collapse of the petrodollar, the US government will be desperate enough to implement capital controls, people controls, nationalization of retirement savings, and other forms of wealth confiscation.
I urge you to prepare for the economic and sociopolitical fallout while you still can. Expect bigger government, less freedom, shrinking prosperity… and possibly worse.
It’s probably not going to happen tomorrow. But we know where this trend is headed.
It’s possible that one day soon, Americans will wake up to a new reality. Once the petrodollar kicks the bucket and the dollar loses its status as the world’s premier reserve currency, you will have few, if any, options.
The sad truth is, most people have no idea how bad things could get, let alone how to prepare…
Yet there are straightforward steps you can start taking today to protect your savings and yourself from the financial and sociopolitical effects of the collapse of the petrodollar.
By Nick Giambruno
Source: International Man