There's Another Global Monetary Shift Happening Right Now

There's Another Global Monetary Shift Happening Right Now
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The oil producers of the world are becoming serious about production. Getting OPEC member nations to live up to their commitments for cuts has always been a challenge right from the beginning. Many of them, of course, have few alternative economic capacities that would readily offset reductions in each respective energy space. It’s one way in which global oil prices are more inelastic than modeled supply/demand curves.

Despite that, Bloomberg reported a few weeks ago that October was the first month in which all OPEC members honored their reductions. Not only were member states in compliance, it was also the first time non-members (including trade groups) were, too, all in an effort to eliminate the worldwide crude “glut.”

When said glut first showed up, it was characterized quite a bit differently. In early 2015 as oil inventories surged, and crude prices crashed, it was all attributed to the economic success of shale production largely in the United States. This “supply glut” was a very good thing, we were told, a boon for consumers as well as US industrial output just as the rest of the economy was poised to throw off the lingering depressive elements still left from the Great “Recession.”

Nearly three years later, it’s not so much a supply glut anymore, at least not alone. Even though WTI as well as other global benchmark prices put in their lows on February 11, 2016, more than a year and a half afterward oil prices haven’t yet retraced half their losses. The variable that changed wasn’t really supply, though that certainly contributed to the speed of the price and inventory shift. What mattered was a clear change in global demand.

The world went through a manufacturing recession that in many places was also a full-blown one (and worse). That meant fewer goods produced, stockpiled, and shipped around. For a commodity getting heavy on the supply side, it was a total shock.

What matters now is the waiting. In typical cycles of even near-recession downturn to upturn little patience is ever required. When the positive cyclical forces take over, there is no need to wait and see the what’s and how’s of it. It happens and everyone knows it, corroborated forthrightly by markets.

Nearing the end of 2017, however, the world is still with bated anticipation. And so the oil ministers and various officials of OPEC and non-OPEC must gather in Vienna to not just agree to yet another extension for production cuts but also expressly harsher words aimed at those who might not be fully in compliance (Russia).

Saudi Arabia’s Energy Minister (for now, I assume) Khalid al-Falih said yesterday, “We must stay the course. If something is working you don’t let go.” Is it?

What it comes down to is what the bond market is saying. The conundrum there isn’t really one at all, of course, since it is in perfect complement with oil stuck considerably below $100 a barrel with another year of production cuts. A world without growth is a world that doesn’t need to use a great deal more oil, and since there is so much of it sitting around in various places, rebalancing supply factors can only remain a significant challenge – which is why OPEC is taking production cuts likely through yet another year.

This is all taking place despite the Chinese contribution, gift really, which has been to import and store crude that that country doesn’t need, at least not right now. China’s economy, a significant marginal factor for the global economy, is slowing again after failing to achieve any acceleration from the 2015-16 downturn. And yet, the Chinese imported 281.1 million tons of crude, 8.44 million barrels per day, during the first eight months of this year. That was 12% more than was brought in during the same months in 2016, already an appreciable increase from prior years.

It wasn’t Saudi Arabia who benefited the most from this uptick in “demand.” Instead, both Russia and Angola have surpassed the Middle Eastern Kingdom in supplying oil to the Chinese this year. For both countries, the latter in particular, that’s mere necessity rather than booming national business interests.

The Chinese have lent Angola, or at least banks within that impoverished African country, at minimum $20 billion (the exact balance isn’t known and is of some debate depending on the source) since its long civil war ended in 2002. Repayment of those loans has become very difficult for the oil producer, what with dollars in short supply due only in part to the mercantile effect on that supply due as the oil price crashed (and failed to recover).

Repayment has increasingly taken the form of crude oil, which for Angola only makes their situation that much more unbearable. Dollars never make it to the real economy, one which is starved for them as the primary means of exchange inside and out. Inflation had been falling previous, reaching a record low for Angola of 8.75% in July 2014. That had allowed Banco Nacional de Angola to reduce its key money rate (BNA reference rate) to less than 9% around that time.

Then the “rising dollar” happened leading to that global downturn and thus the oil “glut.” I wrote in May last year:

“In response, the Central Bank of Angola has no choice but raise interest rates to contain the deafening “dollar” shortage in the real economy that pushes down the exchange value of the kwanza and leads to spiraling consumer prices. With drought hitting southern Africa, supermarkets have to ration food because there are no “dollars” with which to import it and nobody willing to take kwanza with it facing only further devaluation. The situation has deteriorated such that almost all oil output will be heading to China, leaving none left for Angola to source any international currency (RMB doesn’t count).”

Starting in the middle of 2015, the central bank did begin to alter its benchmark rate, hitting 16% by early 2016 where it remains still today. Inflation has returned, with prices rising 26.95% in September 2017 over the prior twelve months in that country, though that is, according to BNA, a positive sign being better than August when inflation was running at nearly 40%.

Though it is easier to understand Angola’s situation, and response to that situation, it actually isn’t any different or not all that much from China’s. They both have a dollar problem, one which affects them greatly; the Chinese as the world’s second largest economy and its industrial powerhouse is simply better equipped to respond to the challenge than the penurious, one-industry Angola.

Taking all or nearly all Angola’s oil in lieu of dollars reduces China’s dollar requirements. At a lower global price, why not obtain all you can? It helps in not just diminishing China dollar demand today but also in the future. It is, however, only a partial solution because the eurodollar system remains, not just as the primary reserve currency but also in a state of such chronic dysfunction that all this is required just to try to see a path back to something like normal all across the world.

Back to last May:

“They [the Chinese] have, in fact, turned a virtual currency into a real commodity by pawning it off on those more desperate for it. In other words, they conjured “dollars” that they themselves don’t really have so that they could position trade factors financially in their favor…From that perspective, the eurodollar is like a highly contagious virus with a long incubation period. Everybody just creates “dollar” IOU’s and spreads them everywhere, leaving behind the contamination of now being ‘short.’”

We entered the systemic situation on August 9, 2007, where global banks who used to conjure and redistribute unreserved dollar IOU’s to every corner of the planet no longer want the job. That makes these IOU’s a far less fluid medium of exchange, and in plain economic terms acts as a clear and present danger for global economic demand – showing up in demand for crude that “somehow” hasn’t yet balanced with ongoing massive inventory stocks.

The world goes but for those two little words; “credit-based.” You can understand why among everyday folks whose knowledge of global interbank finance rightly remains minimal and limited this all seems like unnatural voodoo, but that claim also applies to particularly Western central bankers in an outright abomination, a criminal abdication of responsibility and dereliction of each’s first duty. To hear them tell it, everything up to and including the dollar is fine.

I cannot help but cringe whenever recalling PBOC Governor Zhou Xiaochuan’s March 2009 essay. It was, not coincidentally, published originally by the BIS right during the worst of 2008’s spillover into 2009, the liquidations and bank nationalizations, real and threatened, that all came “somehow” despite TARP, QE, ZIRP, central bank dollar swaps, and more acronyms tied to further emergency programs than I can count that no one remembers because they were just that ineffective.

In his essay, Zhou became the first central banker, and so far only that I have seen, to correctly characterize the global monetary system. The reserve currency is not the dollar; it’s not even a currency by any reasonable standard. It is, as he wrote, a credit-based currency that replaced Bretton Woods, which, as should have been apparent by late 2007 at the latest, makes all the difference. China’s Communists know more about the real dollar than any American official, such is the sorry state of the world.

Without being able to address money supply, a factor which does matter a great deal even for a virtual non-currency currency, you get all the rest described above as well. The wasted energy (pun intended) on trying to make due with an unworkable, chronically insufficient currency regime is non-trivial, and for far more than the world’s vast energy sector. The oil market’s struggles extending now into 2018 and beyond strongly suggest it is a substantial drag.

Official denial notwithstanding, people are starting to get the sense of the problem’s nature if not yet these specifics. In 2017, it’s getting harder not to notice central bankers don’t really know all that much about what they do. They can talk positively about each of their own economies, but growing social and political chaos in this world is all the counterpoint necessary. For ten years, they have said first nothing was wrong and then that it would get better, and yet here we are. It doesn’t matter that this time, they say, they mean it.

In the United States on that very count, the Fed presumes to be raising rates but the bond market just laughs. Long rates have barely budged this year, and are slightly less now than when the second “rate hike” was offered being now in the shadow of an upcoming fifth. As such, the yield curve collapses though it registers the same economic verdict as $57 rather than $107 oil.

The Chinese are not the only people who are exploring monetary workarounds (nor are their attempts limited to African oil swaps; China’s Hong Kong dollar bypass remains troubling but clearly open still this late in November). Bitcoin after being shrugged off as nothing years ago is everywhere now. That’ll happen when any “price” explodes from under $1,000 to over $10,000 within a single calendar year.

The plain truth of the matter is that the global monetary system doesn’t work, the eurodollar as its chronically challenged basis. It doesn’t work for China or Angola, Russia or anyone else up to and including America. Everyone easily accepted it because before August 2007 it appeared to greatly benefit everybody from what it seemed to offer them – none more than China. Call it globalization if you want, but in reality it was always eurodollar driven.

Cryptocurrencies like Bitcoin are the very natural, free market response to what doesn’t work. Interest in it stems largely from the growing realization that central bankers and Economists (same thing) really don’t know what they are doing. They say the world is recovering, but they have said that each and every year since 2008 and still OPEC has to gather in lavish conference rooms in Austria in order to handle a global oil “glut” that not even the Chinese/Africa oil exchange can put much of a dent in. We know where this is all heading, and the more stubborn monetary officials are about it the greater the likelihood it happens that way.

It’s a scary proposition but it needn’t be. There is a whole range of possibilities about how this reset works out; some good, some bad, more than a few really bad.

At the top end most positive is the whimper; the eurodollar system merely fades out slowly toward non-existence as alternate global monetary methods spring up and are just as slowly and non-confrontationally adopted. This would be like Bitcoins supplanting the “dollar” business here and there until it reaches a tipping point toward more universal international acceptance. That’s what’s got it at (for now) $10,000, the potential to be a real currency.

Cryptocurrencies are often attacked for their lack of other monetary functions. Right now, they are almost purely mediums for exchange. But so what? The eurodollar is no different. Its rise was for that function exclusively, too, which is why it is today just as non-reservable when it started more than a half century ago – there are no dollars in it any more than there is gold backing those physical Federal Reserve Notes that don’t have a place there.

That said, cryptocurrencies have considerable weaknesses and risks, starting with, like eurodollars, Economists. Reported by Bloomberg this week:

“Nobel Prize-winning economist Joseph Stiglitz said ‘bitcoin is successful only because of its potential for circumvention, lack of oversight.’”

Once again, that’s exactly what the eurodollar was until in 1971 it took over from Bretton Woods. Long before Nixon’s last monetary act it had already, slowly supplanted gold exchange. Paul Einzig, one of the first, if not the first, mainstream commentators to expose the eurodollar, wrote in 1964:

“The Eurodollar market was for years hidden from economists and other readers of the financial press by a remarkable conspiracy of silence. I stumbled on its existence by sheer accident in October 1959, and when I embarked on an enquiry about it in London banking circles several bankers emphatically asked me not to write about the new practice."

That was to its benefit, for by the time global officials got around to recognizing its significance as purely a global medium for exchange it was already the primary dollar liquidity vehicle offshore. The workings of an increasingly globalized economy had already come to depend on eurodollars long before certainly Federal Reserve officials really knew what was going on.

But being a credit-based currency regime, central bankers came to view it as tamable; falling within their monetary policy reach. A eurodollar wasn’t really a dollar, but the replicated denomination masked that key difference. They were wrong to underestimate its evolution, of course, but that mischaracterization prevailed all the way until August 2007.

Cryptocurrencies, however, are right now totally on the outside of the official spectrum. Thus, Stiglitz also exclaimed, “So it seems to me it ought to be outlawed.” Statists don’t share power. Economists in the realm of money are thorough statists, however they might describe themselves as some range of capitalist.

But while that’s the biggest risk for them, and Bitcoin as the leading beta test for the paradigm, it’s also their biggest strength. As a general idea, cryptocurrencies are one free market attempt to solve the dollar problem, and therefore are already significantly advanced as to Economists who might try to stop them (all of whom yet to realize that there is, you know, a dollar problem to begin with).

More than that, these virtual monetary answers are not credit-based; they at least answer the eurodollar’s biggest drawback in their very basic format. The primary weakness of that system was always that it depended upon the world’s largest banks for all of its functions, including what counts as a bank liability for currency. Such hierarchy when it fails makes it intractable as well as, to most regular people, morally unattractive (TBTF).

The issue is as always one of time. Can Bitcoin scale up its adoption before authorities seek its ban, or, like the eurodollar, even understand it enough to attempt it? When they do, which is probably inevitable, will it happen far enough on down this same troubled eurodollar path to where Economists seeking that ban are no longer taken seriously? Or does the worst case result, where the system becomes untenable and starts to reset on its own? Even in that last scenario, cryptos might be the solution to what has already broken down completely almost surely over the utterly devalued objections of mainstream authorities who in all likelihood would still claim there is no dollar problem.

The eurodollar is a decade into “doesn’t work.” But there is at present no alternative to it, a product of Western denial far more than a minimally positive statement about its perseverance. And one can’t be fashioned and made workable at a moment’s notice. That’s not how these things go. We don’t even know how big the eurodollar problem is right now, what with $14 trillion in “footnote dollars” just being (officially) discovered a few months ago. How do you reprice $25 or $35 trillion in offshore FX, every bit as functional as cash in this eurodollar system, into a new currency? How do you even begin to map out a replacement infrastructure and logistics, let alone implement them?

The normal answer is time, to allow a free system to answer all questions and surmount all problems organically. Competition, even among types of currency, reduces the time component and strengthens what results.

Paradigm shifts might appear to be abrupt, but that’s only because we don’t notice that they are happening until toward the end when we are forced to. The Bretton Woods system didn’t end all at once in 1971. It was subverted for a decade and a half but a purely medium of exchange monetary tool unlike anything anyone had ever seen. In many ways, cryptos are the next step after eurodollars, only now divorced from the banking root.

There is another global monetary shift happening now, one that’s been coming for a very long time, but it’s only just getting to the part where it’s noticeable in the mainstream (2008 was just a brief moment when the world’s attention was focused on what’s behind the curtain, off in those dark global shadows). Part of that is Bitcoin, part OPEC, and a lot this global economy that no matter what is said and done just won’t go.

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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