Major Theme(s) this week
[01. USD = Reserve Currency Forever]
“The USD is, and always will be, a reliable store of value and the global reserve currency.”
Last week there was something of a flap about Saudi Arabia failing to renew “the petrodollar agreement” leading to the imminent demise of the USD as the world’s reserve currency and the probable collapse of the USA itself.
The news was received with a mixture of glee and fear all over the English-language internet.
This article was one of the more restrained treatments of the news:
The 50-year-old petrodollar agreement between the U.S. and Saudi Arabia was just allowed to expire. The term “petrodollar” refers to the U.S. dollar’s role as the currency used for crude oil transactions on the world market. This arrangement has its roots in the 1970s when the United States and Saudi Arabia struck a deal shortly after the U.S. went off the gold standard that would go on to have far-reaching consequences for the global economy. In the history of global finance, few agreements have wielded as many benefits as the petrodollar pact did for the U.S. economy.
By mandating that oil be sold in U.S. dollars (DXY), the agreement elevated the dollar’s status as the world’s reserve currency. This, in turn, has profoundly impacted the U.S. economy. The global demand for dollars to purchase oil has helped to keep the currency strong, making imports relatively cheap for American consumers. Additionally, the influx of foreign capital into U.S. Treasury bonds has supported low interest rates and a robust bond market.
The story was even more popular on the more excitable parts of YouTube, here is Jimmy Dore:
and Kim Iversen:
and Timcast IRL:
And all this happening in the same week in which I was immersed in the St Petersburg International Economic Forum, learning about the narratives of the people who really are trying to de-throne the dollar. The timing seemed almost too perfect!
The Petrodollar has always been a good story and it does make some intuitive sense, if you don’t examine it too closely...
Of course the USD is the reserve currency because the Americans “forced” the Saudis to only accept USD for their oil thus ensuring that the USD will always be backed by the majority of global trade – that makes perfect sense! If the Saudi’s have now ended that agreement then that must be the end (or at least the beginning of the end) of the USD as global reserve currency.
There is only one problem with that story – it’s just not true.
For one thing, there was no Petrodollar Agreement for the Saudis to cancel, and for another there really is no such thing as “the Petrodollar” to begin with.
What Agreement?
I have not actually been able to find the source of the idea that there was an agreement regarding selling Saudi oil for USD that expired on June 8th 2024.
The closest thing I have found is that that date was 50-years since the establishment of the ‘United States – Saudi Arabian Joint Commission on Economic Co-operation’ which was formed shortly after the 1973 oil crisis created by the OPEC oil embargo of those states that supported Israel in the Yom Kippur war of October that year.
Oil price volatility became a politically sensitive issue, domestically, for US President Richard Nixon and so his National Security Advisor, Henry Kissinger, embarked on a concerted period of diplomacy to bring the Saudi’s, and particularly King Faisal, around. These efforts culminated in an understanding (never officially codified into a single agreement) that the Saudis would not embargo the US again and would re-cycle the USD they received from oil sales, investing them in US Treasury securities. In return, the US would effectively guarantee Saudi Arabia’s territorial integrity (and by extension, the rule of the House of Saud) through a series of arms sales and military agreements.
This is the origin of the concept of a “Petrodollar Agreement.”
So, where did the idea come from?
No-one has done more to try and de-bunk the idea of the Petrodollar than Martin Armstrong, so I will let him tell the story, from January last year:
To explain the survivability of the dollar since it rose between 1972 and 1976 against the British pound, with the collapse of Bretton Woods, the rise in gold, and the entire oil embargo, that is when [gold dealers] came up with this idea that the dollar was backed by oil.
All [of their previous] theories were wrong. The dollar rose, inflation soared, and gold declined. None of this made sense under their theories. Something had to be done. It became obvious that it was impossible to make investment decisions based upon these theories that people just made up to sell gold which are still being used today. I also remembered that in January 1970, gold fell in the London market to $34.70. Gold was not supposed to sell below the Bretton Woods fixed exchange rate of dollars to gold. It was like being smacked in the face and told to wake up!
Without question, the dealers could not sell gold if it did not rise with inflation and against the dollar since it was no longer backed by anything. They had to invent something new. That is when the sophistry specialists stepped in and boy did they succeed in bullshitting everyone.
The explanation was ah ha – the dollar is really backed by oil because it is priced in dollars. That’s it. It is really the Petrodollar! Suddenly the dollar became de facto-backed by oil. They needed an explanation to explain why all the old theories were wrong. They sold this theory and it made the front cover of Newsweek. Everyone said YES! That must be the reason. OPEC priced oil in dollars! Naturally, everything was priced in dollars because, under the fixed exchange rate of Bretton Woods, everything from wheat and corn to copper and gold was all priced in dollars.
So, why is the USD the world’s reserve currency?
The position of “world’s reserve currency” is not a formal one with an award ceremony or voting. When we use those words we are using them as a short-hand for “the world’s dominant reserve currency.”
Any currency can be a reserve currency, and many are – the Chinese Renminbi, the Pound Sterling, the Euro and the Japanese Yen. So why is the USD the dominant one? Let’s hear from Martin again:
The requirement of MONEY is that everyone accepts it. The dollar is no more backed by gold, oil, or even propaganda. It is backed by the fact that the United States has a non-Marxist consumer-based economy to which everyone wanted to sell their wares to re-establish their economies. China and Japan rose because they were able to sell to the American consumer. The same was [true] for the German car industry. I know, I was called in by both the Japanese and German car industries. There were no exchange controls on the dollar. Emerging markets issued debt in dollars so they could sell it to American investors.
If sell to the US you will naturally accumulate dollars, it then makes sense to continue to hold onto those dollars, rather than swapping them straight back into your currency (or another), as they are valuable to anyone else who wants to trade with the US – particularly when you want to buy from them, say military equipment.
What does it all mean?
The original incorrect reports and continued widespread confusion around the concept of “the petrodollar” demonstrates (1) the dangers of a rush to be the first to report something exciting and (2) the enduring power of a narrative that makes some intuitive sense and confirms our pre-existing biases – even if it is wrong.
The de-dollarisation of world trade is an on-going process, not an event. It will happen, but only when the US as a market has declined in size and attractiveness to the point where circumstances dictate that a different currency is a better choice as a reserve.
The US themselves is, seemingly, working hard to bring about this necessary change in circumstances but - even with sanctions, kicking nations out of Swift and confiscation of the assets of another country – the US still accounts for one third of global capital flows.
The USD story has a while to run yet.
Also in motion
[06. AI is Awesome!]
“AI will change everything for the better – bigger, faster and more profitable.”
Every week I hope that I have said everything I need to say about AI for a while and I can talk about something else, and every week something new happens. This narrative is shifting and changing faster than any other on the board.
What’s fascinating about it is how it is a blend of two intertwined narratives – the hype and the hardware. For the Hype to pay off, everything that the boosters say has to be true, whereas for the Hardware only needs sufficient people to believe that the Hype could be true – and so shell out for container-loads of chips!
The Hype begins to cool?
The inimitable Gary Marcus kicks us off this week with a post on the gradual public admittance by some of the most prominent AI-world names, that their predictions about the “imminent” arrival of Artificial General Intelligence (AGI) need to be walked back somewhat:
It was always going to happen; the ludicrously high expectations from last 18 ChatGPT-drenched months were never going to be met. LLMs are not AGI, and (on their own) never will be; scaling alone was never going to be enough. The only mystery was what would happen when the big players realized that the jig was up, and that scaling was not in fact “All You Need”.
Yann LeCun, was to his credit, one of the first off the sinking ship (I of course refused to board in the first place), calling LLMs an “off-ramp” to AGI. But that was only after ChatGPT ate Galactica’s lunch; until then he was publicly supportive even if privately skeptical.
Others are bailing now, too. Or at least trying to subtly alter their positions, committing less to the unrealistic.
Then we had the news that McDonalds is abandoning its 2-year long experimentation with using an AI-powered chatbot for drive-thru ordering at more than 100 restaurants.
And it does appear that investors are starting to get wise to the gap between the hype and the reality, reporting from the FT:
Most of the stocks that were caught up in last year’s hype around artificial intelligence have fallen this year, suggesting that investors are increasingly trying to separate the wheat from the chaff among companies claiming to be beneficiaries of the AI trend.
But the recent declines for dozens of stocks that had benefited from the early enthusiasm suggest that investors are starting to look past optimistic commentary if the companies cannot back up their claims. “AI is still a big theme but if you can’t demonstrate evidence you’re getting hurt,” said Stuart Kaiser, head of US equity trading strategy at Citi. “Just saying ‘AI’ 15 times is not going to cut it any more.”
Finally, I want to point you to this excellent polemic by an actual data scientist, the rather wonderfully titled “I Will Fucking Piledrive You If You Mention AI Again.”
I started working as a data scientist in 2019, and by 2021 I had realized that while the field was large, it was also largely fraudulent. Most of the leaders that I was working with clearly had not gotten as far as reading about it for thirty minutes despite insisting that things like, I dunno, the next five years of a ten thousand person non-tech organization should be entirely AI focused. The number of companies launching AI initiatives far outstripped the number of actual use cases. Most of the market was simply grifters and incompetents (sometimes both!) leveraging the hype to inflate their headcount so they could get promoted, or be seen as thought leaders.
What does it all mean?
If you have read any of our previous issues, you will know what we think. The hardware angle has been the way to play the AI narrative. An enormous amount of money has been spent on that hardware, however, for precious little return. A correction is coming.
[10. Battery EVs are the future]
“Battery powered electric vehicles are the future of personal transport.”
This is another narrative where the hype seems to be fading.
First up is Tesla wannabe, Fisker, which filed for bankruptcy protection, reporting was all over the internet, but these quotes are from the WSJ:
Fisker is the latest among a crop of once high-flying EV startups that looked to upend the traditional auto industry but have run out of charge. Pickup maker Lordstown Motors and bus manufacturer Arrival both filed for bankruptcy protection. Others are cutting costs or delaying investments, in an effort to conserve their remaining cash.
The company’s current challenges underline the hurdles facing young carmakers that have sought to emulate Tesla’s success. Many of them raised billions of dollars from investors in splashy public debuts but ran down their cash reserves as they spent heavily to develop new models and build out factories and sales centers, all while losing money on every vehicle sale.
And speaking of Tesla, the FT published this interesting breakdown of EV sales by manufacturer showing that Teslas (a premium product) are the only make selling in size in the US market:
This confirms our supposition that while EVs are here to stay, they are not a mass-market product – certainly not when the cheap Chinese ones are getting slapped with hefty import tariffs!
Via ZeroHedge, we learn that EV sales in Germany plummeted 30.6% in May, year-on-year and that a survey conducted by none other than McKinsey revealed that 46% of EV owners in the US will likely return to driving gas-powered vehicles.
What does it all mean?
Starting a car company, at least one that can actually survive for a bit, is a lot harder than it looks. Persuading people to switch to electric vehicles when they do not live in a place with a charging infrastructure is really hard, and especially when your narrative is “its a Ford, just electric.”
Tesla works because it has a different narrative to a traditional car manufacturer – some mix of fashion, politics and techno-optimism.
Most everyone who wants an EV in the West, can afford one and has a living situation that allows for easy charging, already has one and so EVs become a premium product, not a mass-market one – we see this in the dominance of Tesla.
Caught Our Eye
[16. The West is Poorer than you Think]
“Western societies are much poorer than than is generally understood/accepted.”
Following on from our discussion about Russia and measuring GDP on a Purchasing Power Parity basis, here is an interesting article from Asia Times suggesting that China’s GDP numbers might have been massively understated for years.
[08. Go Woke and DEI!]
“Equality of Outcome > Equality of Opportunity. Diversity is our strength.”
Disney exec gets caught on camera saying that they “don’t hire white males”, but given the poor ratings of their recent output it seems that the people they do hire are not doing a great job.
[04. Gold is a barbarous relic]
“Gold has no place in the modern investor’s portfolio – it is still a barbarous relic.”
This narrative continues to weaken, as it emerges this week that not only emerging market Central Banks are buying gold.
Dimensions Grid
Here is a snapshot of the full grid as it stands at the close of this week. Changes versus last week, highlighted as always. Discussion of what the dimensions and values mean is here.