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KAOBOY MUSINGS and its associated podcast KAOS THEORY focus on the intersection of Financial Markets, Macroeconomics and Geopolitics. I've spent 30+ years as a trader/hedge fund manager and now manage money for my family office across many asset classes.

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Re: USD Wrecking Ball World Tour & The CNY Facade.

Lots of hyperventilation lately over the “weaponization of USD”/imminent doom of USD hegemony as a result. While the de-dollarization narrative is seductive, the USD remains the “cleanest dirty shirt"

Michael Kao

Mar 14, 2022

I’ve written about the determinants of RELATIVE value for currencies. While Debt/GDP is one factor, a myriad of other factors go into the determinants of “safety and soundness.” This thread talks about geographical/geopolitical determinants of value:

Kaoboy Musings

Re: Oil/Inflation-“Are we headed for Weimar, or is it just Hyperinflation Hyperventilation?”

My Thesis: It will create inflation for sure, but this in and of itself will force a self- correcting negative feedback loop that may prick asset bubbles but will prevent a much worse positive feedback loop that eventually breaks the system. When you analyze a company’s creditworthiness, you have to focus not just on its cashflow/income statements, but a…

3 years ago · Michael Kao

Moving to the USD specifically, this thread links the developing STRUCTURAL supply deficit in oil (now greatly exacerbated by Russian disruptions) to how the USD is not only the “cleanest dirty shirt” but is poised to STRENGTHEN into a USD Wrecking Ball:

Kaoboy Musings

Re: Oil and the USD Wrecking Ball.

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…

2 years ago · Michael Kao

In this thread, I’m going to use 10-year charts to give context and point out the direction of USD relative STRENGTH since currency quoting conventions can be confusing (some currencies default to USD as the denominator, whereas others have USD as numerator).

Let’s dispel the notion that Debt/GDP should be the sole determinant of value and look at the Russian Ruble (RUB): UP = USD STRENGTH. Debt/GDP=20%. Note the consistent weakening even BEFORE the war/sanctions:

How about Turkish Lira (TRY) with Debt/GDP of 38%? UP = USD STRENGTH.

Okay, okay, I’m picking on EM “basket cases” right? Why don’t we look at the DXY (USD Index) next, comprised of a trade-weighted basket of FULLY CONVERTIBLE currencies of the US’ largest trading partners:

Here’s the chart of DXY (UP=USD STRENGTH):

Let’s go further and look at each constituent cross-rate within the DXY. Let’s start with the Euro EUR (57.6% of DXY). EUR is an example where USD is the NUMERATOR so here DOWN = USD STRENGTH:

Incidentally, if we really are headed into an increasingly multipolar world with European countries needing to fend for themselves militarily, what happens if the EUR breaks up?

Next, we have Japanese Yen JPY (13.6% of DXY). UP = USD STRENGTH.

Canadian Dollar CAD is next (9.1% of DXY). UP=USD STRENGTH. What’s notable here is the recent USD relative strength/uptrend DESPITE CAD being a commodity centric economy which should theoretically make CAD go in the opposite direction.

Swedish Krona SEK is next (4.2% of DXY). UP = STRENGTH. This one kind of surprised me, but perhaps the weakening against USD has to do with geopolitical proximity to Russia.

Lastly, we have the Swiss Franc CHF (3.6% of DXY). UP=USD STRENGTH. CHF has always been a bastion of relative strength against most currency crosses, but in recent days even CHF is weakening against USD.

What about the British Pound GBP since it is in the G7? Again, GBP is quoted as USD/GDP so DOWN=USD STRENGTH.

Even the Norwegian Krone NOK has been giving ground to USD lately despite a commodity-centric economy. UP=USD STRENGTH.

Well, we’re down south, let’s also visit Brazil. Interestingly, the Brazilian Real BRL is one of the ONLY currencies that has been strengthening against USD RECENTLY despite a LT trend of weakening. Presumably this is because of its commodity-based economy. UP=USD STRENGTH.

Let’s pivot to ASIA now, ex-Japan and ex-China (don’t worry – we will get to CNY). Let’s focus on FREELY FLOATING currencies for now and start with the Singapore Dollar SGD. UP=USD STRENGTH. Singapore controls the Malacca Strait incidentally.

Here’s the South Korean Won KRW. UP=USD STRENGTH. K-pop apparently ain't cuttin' it.

What about a blast from the ('97-'98) past? Here’s the Indonesian Rupiah IDR. UP=USD STRENGTH. Note that this is one of the largest oil producers in Asia and the 4th most populous country in the world (US is #3).

While we're reminiscing about ’97-’98, let’s also visit the Thai Baht THB. UP=USD STRENGTH.

How about the Malaysian Ringitt MYR? UP=USD STRENGTH.

Even a DM currency like the Australian Dollar AUD has been losing ground to the USD recently, despite Australia being another commodity-centric economy. DOWN=USD STRENGTH.

What about the 2nd most populous country in the world India. Here’s the Indian Rupee INR. UP=USD STRENGTH. Ouch – this is SCARY given the impending food and energy shortages, which are USD-denominated.

Finally we get to the Chinese Yuan CNY and talk about how the geopolitics of OIL are very BAD for China and why this façade of CNY strength is just a façade. UP=USD STRENGTH.

By now, you should have noticed a pattern around the world of USD STRENGTH, which is largely explainable by the US withdrawing its record COVID-induced monetary expansion FASTER than the RoW.

Even countries that are big OIL exporters are seeing relative WEAKNESS relative to the USD (see NOK, MXN, CAD, AUD, INR above).

How then can a country that is SHORT food and SHORT energy that is EASING because of Evergrande and because of endless COVID lockdowns be bucking the trend and showing CNY STRENGTH (as some pundits love to point out as an example of impending USD doom)?

Because CNY is a NON-CONVERTIBLE currency and is FIXED by the PBOC. This is the reason why CNY is NOT in the DXY despite large trade balances with the US.

What about the “weaponization of the USD” driving market-share of petrodollars away from the USD?

From Lakshmi at Capital One: “Currently all but Iranian imports to China/India (traded in CNY/INR) and Venezuelan imports to a China are traded in USD. As of Feb that is under 2% of total market.”

“If all seaborne Russian barrels were to be placed into China and India (remember Energy is NOT sanctioned and Europe is still paying Russia for piped volume) that would be ~6%.”

And that’s the outside case, because #1: There are limited land routes for oil into China:

But if Russia continues to escalate, it presents a very interesting #2: Russian seaborne oil originates out of Primorisk and Ust Langa (Baltic Sea) and Novorossiisk (Black Sea) -- all of which are easily blockable by NATO.

Turkey (NATO member) has already signaled its intention to blockade the Russian navy through the Bosporus chokepoint out of the Black Sea.

https://www.hurriyetdailynews.com/turkey-blocks-warships-from-bosphorus-dardanelles-171879

If push came to shove, the Scandinavian countries of Denmark/Norway (NATO members) and Finland/Sweden could easily block the Danish Straits through the Baltic. Don’t forget about Poland, Estonia, Latvia, and Lithuania either as troublemakers for Russia.

If Russia were to miraculously reroute all of its oil up through Murmansk and leave via the Norwegian Sea, Her Majesty's Naval Service of the UK could easily intercept via the North Sea.

Russia is now surrounded by hostiles, and even a desperately oil-thirsty China would have second thoughts sending its tankers through many potentially hostile waters to get that Russian crude. We haven’t even talked about the Strait of Malacca, have we?

I’m going to end this thread by reiterating my thesis that CNY is at great risk of DEVALUATION against the USD and why:

Not only does CNY have no hope of supplanting the USD as a reserve currency, I think China faces a precarious crossroads:

End of thread. Let the arrows fly.