Monday, August 7, 2017

Luke Gromen: US Dollar Starting to Lose Its Monopoly on Oil Pricing

Luke Gromen is a market analyst who Founded FFTT (Forest for the Trees). That is a newsletter that provides insight on big picture macro ecomomic trends for institutions and individual investors. His newsletter is popular with some blog readers here as well. 

Recently, he did an interview with Incrementum where the future role of the US dollar was discussed. Below are a few interesting excerpts from this interview and then some added comments. Also below is some input from a blog reader about Luke Gromen.


Luke Gromen

Highlights of the conversation:

Luke Gromen:

The dollar is losing its monopoly on the pricing of oil 

► China is effectively “re-opening” the Bretton Woods gold window through the yuan 

► This has already begun driving physical gold market flows from west to east, and we expect that to continue given gold’s historic undervaluation v. the US dollar 

► Certain US state pension funds running into trouble despite an “everything bubble” are a sign of broader and worsening US fiscal problems, which could have important implications for the US economic and political situation as soon as 2H17E. 

► I believe the dollar will weaken, and the yuan will strengthen 

► The market-wide Schadenfreude towards gold holders, is now shifting

Ronald Stöferle:

"Luke, let’s talk about something you know a lot about: the long awaited oil contract in Chinese yuan (RMB) just began testing for an expected late-July launch. And you said there is no other development in capital markets that is as important as this. Once it goes live it significantly increases China’s ability to control the value of the dollar through oil and gold markets, through simple arbitrage."

Luke Gromen: 

"I think there are two major changes that started accelerating in the third quarter of 2014. For the first time in 70 years US Federal deficits are beginning to matter to the US. In 2004 US Vice President Dick Cheney reportedly said “Reagan proved deficits don’t matter”. Importantly, Cheney was right as long as the world continued to sterilize dollar outflows by stockpiling FX reserves, which were primarily dollar denominated. But beginning in Q3 2014 global FX reserves peaked and began falling for the first time, and at the fastest pace, in 70 years. It’s something that nobody trading today has seen in their career.

The second big change is that the dollar started to lose its 44 year old monopoly in the pricing of oil as China and Russia signed the “holy grail gas deal”, and it was later revealed that some of those transactions would take place in yuan and not dollars. And we have seen more of this de-dollarization accelerate globally since. We believe that China is trying to gain the ability to print yuan for oil and become only the second nation in the world that can print domestic currency for oil (the US currently being the only one that can do that). Our opinion is that nobody trusts the yuan, but if China offered credible gold settlements to its energy partners, then China’s energy exporting partners would increasingly be willing to settle oil in yuan."

My added comments: Here in this one brief Q&A exchange, we see the very kind of thing we watch for here discussed. Recently, we ran this article asking Why Does the US Dollar Remain at the Center of the global Monetary System? In that article we said this:

"I have come to the conclusion that the majority of the world has become so dependent on the idea that the US dollar is a safe currency for so long that changing that perception has become almost impossible for anyone now so long as things appear stable. While many various interests around the world are making attempts to try and get something to challenge US dollar's reserve status, an entire generation has grown up now not knowing anything else. It is simply very hard to make a huge sea change like this unless events force that kind of change to take place.This is why I have decided it will most likely take a new major global financial crisis of the kind Jim Rickards and others have talked about to shake the world's desire to hang on to the US dollar."

The changes that Luke Gromen talks about are the kind of thing that could lead to a reduced role for the US dollar as global reserve currency and should be watched carefully. The question for me is how long will this process take? Months, years, a decade or more?

At the current pace of change, the process will unfold gradually over many years and could take even take a decade or more. What could change the current pace?

- a new major global financial crisis that forces a replacement of the US dollar as global reserve currency to try and solve the crisis 

- strategic decisions by China (and probably along with Russia) to aggressively attack the US dollar as global reserve currency (at a faster pace than they are now) similar to what Luke Gromen talks about above

- some other as yet unknown event that no one currently foresees like an unexpected decision by the US to call for a conference on a new monetary system or "new rules of the game"

When I started this blog back in 2014 there seemed to be a lot of consensus that big changes in the monetary might be imminent. Many credible sources within the system and outside critics of the system seemed to be in agreement on that. It's why I started the blog in the first place. Now it's almost four years later and no major changes have happened or appear to be imminent right now. 

This why I have made the decision to continue to monitor this situation until mid 2018 to see if any signs that major changes might be coming appear. I have little doubt that over time we will see a process unfold where the role for the US dollar is reduced and other competing currencies take on an increased role. The question again is how long does the process take and what will arise to challenge the US dollar? The Yuan? A new version of the SDR? A modernized version of gold? Something else (decentralized cryptocurrencies)? Some combination of the above?

If it happens sooner rather than later, it will make sense to continue to monitor the process here with regular articles. If the process takes years or a decade, it does not make sense to continue with regular articles here on the blog because people will simply lose interest in the subject which is understandable. Under that scenario, it is not likely to be something they see as a direct impact to their daily lives because the changes would be small and incremental over time. Piecemeal engineering is the term Jim Rickards gave me for this process.

At this time, I feel like it should be clearer by mid 2018 which way things are more likely to go over time. The election of Donald Trump has created somewhat of a new wild card, but by mid 2018 it should be clearer how he may impact the process or not. 

Of course, if we do get another major new crisis for any reason, it will be obvious and many people will quickly start to pay attention and want more information like we have collected here (see links in upper right hand corner of the blog). That information will stay available and should continue to be pretty relevant over time. I would also try to produce regular articles as well under that scenario.
Added note: I got this email input from a regular reader here who follows Luke Gromen and has pointed me to his work:

"I keep up an irregular correspondence with Luke.  He has been following a new twitter account, @ForbinsFolly, which he says is providing information about a Chinese plan to extend yuan oil denominated trade (which already exists with Russia ) to both Iran and (under current negotiation ) Saudi Arabia as well (use Google translate).  The key to all this, he says, is the new yuan and dollar denominated gold contracts which are now launched at the SGEI (Shanghai Gold Exchange), and which allow for physical settlement (unlike COMEX, for example ).

This would (if achieved) affect both the dollar/oil and dollar/gold ratios, under a new “petro-yuan” recycling system with gold as an available, but not automatic, settlement medium for trade imbalances; though both countries would try to balance trade by more conventional means first (that being goods and services exchange).

Anyway, lots to think about, for sure." 

Additional added note: Jim Rickards provides his thoughts on the 3 way chess match between the US, Russia, and China

BullionCoin Update 8-7-17: BullionCoin is supposed to launch a web site and provide a white paper sometime this week. Even after doing many hours of research on BullionCoin trying to learn about it from the information on this web site and making a number of attempts to get direct information, I am not sure what will be announced this week. The only available information that I know of at this time is this comment on Twitter. Once something is announced it will easier to assess the potential impact of BullionCoin as a news story to cover. It would have to be something that significantly impacts the gold and silver market and have substantial institutional support to make sense to continue to cover it here. We should have a better idea sometime this week.

BullionCoin Update 8-7-17: This article link about BullionCoin shows up on Kitco and includes a link to this web site with a bit of information. Nothing new here, but an indication that the actual launch is likely close if a link to an article like this shows up on Kitco.

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