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Re: Oil and the USD Wrecking Ball.
A lot of my recent Musings have been around how surprising USD strength could be hugely destabilizing for certain parts of the world <cough, “China!”>.
I am going to pull some of these thoughts together here.
Since the current decade is already looking like the 70’s in many ways (ignominious defeat on the global stage, energy crisis, inflation, new ABBA album, etc.), let’s go back to something else that happened in 1974: the establishment of the PETRODOLLAR system.
Read about it here.
https://www.investopedia.com/articles/forex/072915/how-petrodollars-affect-us-dollar.asp
Basically, it was a “protection racket.” Nixon struck a deal with the Arab states to standardize the sale of oil based on USD in return for “protection.” Disproportionately beneficial for the US as it created an ecosystem with more network effects than ETH can ever dream of.
There are many pundits in FinTwit (usually those long positions in BTC) foretelling the imminent demise of the USD as GRC (Global Reserve Currency) for this reason or that reason. I am here to call bullshit on that thesis.
How Petrodollars Affect the U.S. Dollar
We examine the rise of petrodollars, their influence on the USD as a global reserve currency, and their effects on U.S. markets.
https://www.investopedia.com/articles/forex/072915/how-petrodollars-affect-us-dollar.asp
There are many reasons to hate the USD – esp. in light of the seemingly incessant “money printing” from both excessive monetary AND fiscal pumps. BUT, like a thick- skinned comedian dodging rotten tomatoes, the USD has shrugged off every insult and exhibited amazing resilience.
Why HAS the USD been ripping lately despite unprecedented expansion of our monetary supply?
First, the determinants of value for the USD are manifold, and to base a “dollar demise thesis” on a single-variable regression to “Debt/GDP” is as misleading as basing a “world demise thesis” on a single-variable regression to “atmospheric carbon concentration.”
The world of FX in particular is about RELATIVE VALUE and COMPARATIVE ADVANTAGE. One can’t legitimately say that one “hates the USD” without also saying “relative to what.” Sorry, BTC does NOT fix this, so don’t even go there. What’s left? EUR? JPY? CNY?
Before we even go back to the petrodollar system, there are many other reasons why the world has chosen the USD as GRC – despite the repeated insults we’ve thrown at it in terms of escalating Debt/GDP.
Again, we need to take a step back and think about what other COMPARATIVE ADVANTAGES we have over other countries.
I wrote a thread a while back about why our GEOPOLITICAL ADVANTAGES are unparalleled, which would explain reflexive “safe haven” bids for our USTs and the USD when the rest of the world shits the bed -- IN SPITE OF AN AGGRESSIVE WEAK DOLLAR POLICY.
The other reason I think the USD has been strengthening is ironically related to the structural bull-market emerging in OIL. “Ironic” because the traditional relationship between USD and oil has been an INVERSE correlation.
BUT that inverse correlation has been breaking down. This article gives some reasons:
https://www.babypips.com/learn/forex/us-dollar-and-oil-relationship-changing
If anything, I think oil’s secular STRENGTH is driving USD STRENGTH this time around, because 1) oil is by far the largest cap-weighted commodity...
2) its strength is derived from structural issues years in the making but hugely exacerbated by current policies, 3) oil inflation is NOT likely to be transitory.
As such, OIL INFLATION has ALREADY opened the Overton Window to an early taper (weren’t the USD doomsayers preaching “QE forever” just a month ago?) and will likely do the same for HIKING, despite Powell’s best attempts to be “stock market whisperer” yesterday.
When Powell abruptly drops both “transitory” and the “2% inflation target” in his rhetoric, do you trust him when he says that “rates will remain near zero until we reach full employment”? All it takes is triple-digit oil to change that tune!
So how does this create a stronger USD? Aside from qualitative “comparative advantage” factors I mentioned, FX exchange rates are driven quantitatively by CHANGES IN INTEREST RATE DIFFERENTIAL EXPECTATIONS between countries.
In the US, we have a strong economy, a tight labor market (to quote Roman Roy, “as tight as a scrotum over a timpani drum”), and strongly rising inflation expectations – all of these portend a regime shift from EASING conditions to TIGHTENING conditions here.
As an aside, I wrote another thread about ramifications of this regime shift on risk assets:
The problem is that the RoW’s economies are NOT nearly as hot as ours – generally speaking, our COVID vax rates have been better, we have not (YET) experienced the extreme energy shortages in Europe/China, we have stimulated our economies MUCH more.
Welcome to the USD Wrecking Ball.
These economic disparities imply UNSYNCRONIZED MONETARY POLICIES with the US leading the regime shift to tighter policies.
And because FX rates are determined by changes in interest differential expectations, the USD has and will continue to STRENGTHEN until global economies synchronize again.
Re: Oil and the USD Wrecking Ball.
I'm pinning this old thread given OPEC+'s Surprise Cut today.
This is the first thread I wrote in which I linked OIL to the USD Wrecking Ball. I believe today's surprise cut is significant in that it potential puts us back to Square One on Inflation, circa 2021.
OIL started the Inflation Conflagration, which eventually spread into stickier components. If Oil is ascendant once again, it calls into question the entire imminent Fed Pivot thesis, which many asset classes are pricing in.