Oil is a key commodity in the de-dollarisation process.
Changes in energy market dynamics
Oil is a key commodity in the de-dollarisation process. One reason for the dollar’s historical dominance is the US-Saudi settlement in the 1970s to invoice oil in petrodollars, which underpinned a dollar-based network of trade and finance. Yet today, China has overtaken the US as the world’s largest importer of crude oil, driven in part by the rise in US domestic oil production over the last ten years. US oil production, which has surged since 2010, is expected to continue growing by around one million barrels a day for each of the next five years. Indeed, it is remarkable the degree to which the production trend has continued rising despite the oil price crash in 2015-2016. Rising production has already led to lower imports into the US, with imports falling roughly 25% since 2010. Consequently, the US will buy less Middle Eastern and international crude, at precisely the same time the Chinese are buying more.
It is the resulting Chinese trade deficit from oil imports that provides the impetus for de-dollarisation, since China would prefer to settle its trade bill in renminbi if possible. Petroyuan futures launched in March on the Shanghai International Energy Exchange have already overtaken dollar-denominated oil futures traded in Singapore and Dubai in volume terms.8 The first physical shipments tied to petroyuan futures began last summer.
Oil companies in Russia, Iran and Venezuela have already begun accepting yuan as payment for Chinese imports, and were Saudi Arabia to follow, the impact could be substantial. A Saudi decision to invoice oil not in petrodollars but in petroyuan could underpin the rise of a substantial petroyuan network of trade and finance and may therefore turn out to be significant.
The new crude buyers on the block
Source: BP statistical review, 2017
A dollar down cycle
Finally, there is a cyclical component to timing de-dollarisation. The next few years may well coincide with a dollar down cycle, which typically accelerates the adoption of other currencies. The dollar tends to move in long cycles, typically around six to ten years each time. It declined through most of the 1970s, rose until the Plaza Accord of the mid-1980s, fell from the late 1980s to 1992, rose again until 2002, and then declined until the global financial crisis of 2008. Currency adoption is procyclical, and during each of these periods, other currencies increased their share against the dollar. For instance, pound sterling use accelerated in sovereign reserves between 2002 and 2008 to 4.8% from 2.7%. Even if one considers revaluation effects, sterling’s share of sovereign reserves increased materially during this period.
After spending six of the last seven calendar years on the up, another dollar down cycle may begin this year. Expensive fundamental valuations and poor technicals, which include significant foreign ownership and waning cash repatriation by US companies, will likely undermine support for the dollar. Moreover, growing concerns about budgetary trajectories in the US mean that the next cycle may offer an indication of the potentially higher risk premia investors will apply to US assets. Forecasts of the US Congressional Budget Office show US debt hitting 152% of output by 2048 from 78% today on the current fiscal trajectory, as social spending and Trump’s tax cuts cement that long-term deterioration.
Given the historical lags between the dollar’s market price behaviour, and current account and budget deficits, it seems likely that the dollar could fall materially in less than two years. Of course, interest rate differentials are still in favour of the dollar, and while that may change as the European Central Bank and the Bank of Japan normalise policy, there is also every chance that it is US rates that converge lower.
US twin deficits are a leading indicator of dollar weakness
Source: Investec Asset Management, 2018
Where to from here?
The emergence of a genuinely multipolar world will have a profound impact on markets and portfolios. We are already seeing the world starting to de-dollarise in important ways, a trend aggravated by the strategic rivalry between China and the United States. This movement could gather pace with the next dollar down cycle, which could begin as early as this year. Structural economic shifts in China mean the country will need an internationalised currency sooner than later. This would require the Chinese authorities to continue undertaking bold capital market reforms and other policy changes. But how far will China go with its reforms? Given the uncertainty of any currency transition, our research looks at three potential scenarios and their investment implications. This key topic is covered in our paper, The next global currency shift: scenarios and investment implications.
1 Doff, N., Andrianova, A., “Russia buys quarter of world yuan reserves in shift from dollar,” Bloomberg, 10 January 2019.
2 Peel, M., “Can Europe’s new financial channel save the Iran nuclear deal?”, Financial Times, 4 February 2019.
3 “EU Chief aims to boost euro’s role in world markets,” Associated Press, 12 September 2018, https://www.apnews.com/fa72ac5836414cd2985988feec6fcfad
4 Martin, F.E., Mukhopdhyay, M., and Hombeeck, C., “The global role of the US dollar and its consequences,” Quarterly Bulletin, Bank of England, Fourth Quarter 2017, p.1.
5 “People’s Republic of China: 2018 Article IV Consultation-Press Release; Staff Report; Staff Statement and Statement by the Executive Director for the People's Republic of China,” International Monetary Fund, July 26, 2018.
6 Reid, J., Mahtani S., Templeman, L., “Tomorrow’s robots and economic history—Not a job killer,” Konzept #13, June 2018.
7 “Chart of the week: China’s thrift, and what to do about it,” International Monetary Fund, 26 February 2018.
8 Mathews, J.A., Selden, M., “The rise of the petroyuan,” Project Syndicate, 3 December 2018.
*Other contributing authors
Greg Kuhnert | Peter Eerdmans | Michael Spinks | John Stopford | Iain Cunningham | Wilfred Wee | Tom Nelson | Michael Power | Imran Ahmed
This content is for informational purposes only and should not be construed as an offer, or solicitation of an offer, to buy or sell securities. All of the views expressed about the markets, securities or companies reflect the personal views of the individual fund manager (or team) named. While opinions stated are honestly held, they are not guarantees and should not be relied on. Investec Asset Management in the normal course of its activities as an international investment manager may already hold or intend to purchase or sell the stocks mentioned on behalf of its clients. The information or opinions provided should not be taken as specific advice on the merits of any investment decision. This content may contain statements about expected or anticipated future events and financial results that are forward-looking in nature and, as a result, are subject to certain risks and uncertainties, such as general economic, market and business conditions, new legislation and regulatory actions, competitive and general economic factors and conditions and the occurrence of unexpected events. Actual outcomes may differ materially from those stated herein. All rights reserved. Issued by Investec Asset Management, March 2019.