Don't you go rehypothocating on me.
(hyperlinks and emphasis in original omitted)
War encumbers commodities.
A recurring theme in my dispatches this year has been that in a moment when the world is going from unipolar to multipolar, the actions of heads of state are far more important than the actions of central banks. That is because heads of state lead, their actions affect inflation, and central banks merely follow by hiking rates to “clean up”. Central banks will be behind the curve in this game, and if investors read only the speeches of central bankers but not statesmen, they will be even more behind the curve. The multipolar world order is being built not by G7 heads of state but by the “G7 of the East” (the BRICS heads of state), which is a G5 really but because of “BRICSpansion”, I took the liberty to round up.
The special relationship between China and Russia has a financial agenda to it, and what President Xi and President Putin say about the future of money – that is, the future they envision – matters for the future of the U.S. dollar and liquidity in the U.S. Treasury market. Their actions are forging something new: Bretton Woods III is slowly taking shape, and in light of developments to date, my motto for Bretton Woods III – “our commodity, your problem” – remains apt.
President Xi’s visit with Saudi and GCC leaders marks the birth of the petroyuan and a leap in China’s growing encumbrance of OPEC+’s oil and gas reserves: with the China-GCC Summit, China can claim to have built a “special relationship” not only with the “+” sign in OPEC+ (Russia), but with Iran and all of OPEC+... President Xi’s visit was the very first China-Arab States Summit in history, and echoes FDR’s meeting with King Abdul Aziz Ibn Saud on Valentine’s Day 1945 aboard an American cruiser, the USS Quincy. Fixed income investors should care – not just because the invoicing of oil in renminbi will hurt the dollar’s might, but also because commodity encumbrance means more inflation for the West.
Here are the key parts from President Xi’s speech at the China-GCC Summit (all emphasis with orange underlines are mine): “In the next three to five years, China is ready to work with GCC countries in the following priority areas: first, setting up a new paradigm of all-dimensional energy cooperation, where China will continue to import large quantities of crude oil on a long-term basis from GCC countries, and purchase more LNG. We will strengthen our cooperation in the upstream sector, engineering services, as well as [downstream] storage, transportation, and refinery. The Shanghai Petroleum and Natural Gas Exchange platform will be fully utilized for RMB settlement in oil and gas trade, [...] and we could start currency swap cooperation and advance the m-CBDC Bridge project”.
Let’s dissect President Xi’s comments bit by bit, and color them with other pieces of information as we go along. First, what is the “duration” of this theme?
It’s pretty short: in the words of President Xi, “the next three to five years”. In market terms, that means that five-year forward five-year inflation breakevens should be discounting a world in which oil and gas is invoiced not only in dollars but also renminbi, and in which some oil and gas is not available for the West at low prices (and in dollars) because they have been encumbered by the East. But it does not appear that breakeven expectations reflect anything like that...
My sense is that the market is starting to realize that the world is going from unipolar to multipolar politically, but the market has yet to make the leap that in the emerging multipolar world order, cross-currency bases will be smaller, commodity bases will be greater, and inflation rates in the West will be higher...
Inflation traders should be paranoid, not complacent. As Andy Grove said, “only the paranoid survive”, but when I asked a small group of inflation traders over dinner in London this summer about how the market (they) comes up with five-year forward five-year breakevens, I did not sense any degree of paranoia in their answer: “there is no top-down or bottom-up work that we do to come up with our estimates; we take central banks’ inflation targets as a given and the rest is liquidity”. Inflation breakevens do not seem to price any geopolitical risk.
Second, “paradigm” in “a new paradigm of all-dimensional energy cooperation” is a symbolic word. The meeting between FDR and King Abdul Aziz Ibn Saud was a new paradigm too: the U.S.’s security guarantees for the kingdom for access to affordable oil supplies. Over time, the paradigm boiled down to this:
the U.S. imported oil and paid for it with U.S. dollars, which Saudi Arabia spent on Treasuries and arms and recycled the leftovers as deposits in U.S. banks. (In the wake of the OPEC shocks of the 1970s, that recycling of petrodollars led to the Latin American debt crisis in the 1980s.) The old paradigm worked...
...until it didn’t:
the U.S. is now less reliant on oil from the Middle East owing to the shale revolution, while China is the largest importer of oil; security relations are in flux (see here); Saudi holdings of U.S. Treasuries and bank deposits are down as the kingdom went from funding the U.S. government and banks to owning equity in firms; and the Saudi crown prince said recently that the kingdom could reduce its investments in the U.S. (see here). Similar patterns hold in other GCC countries.
The “new paradigm” between China, Saudi Arabia, and GCC countries is fundamentally different from the one struck aboard USS Quincy. Naturally so, as China is now dealing with a rich Middle East, whereas FDR was dealing with a Middle East that had just started to develop. With wealth, power and priorities shift:...
....MUCH MORE
