Goodbye Petrodollars: China Recruits Saudis for All-Energy Yuan Team
Chinese President Xi Jinping last month made Saudi Arabia and other Arab Gulf states a bold offer: China will keep buying their oil and gas for the “long term” — but paid for in yuan instead of dollars, the only currency in which oil has traded widely for the last 75 years. China in return will sell the Arab states solar and other high-tech equipment and manufacturing capability, helping them diversify economically while their oil is still saleable.
Western commentators haven’t paid much attention, insisting the Saudis and their neighbors will stick with the dollar, and ignoring the rest. The Arab producers themselves haven’t commented officially. But it’s an offer the Arabs will find hard to refuse, especially with the sweetener of major assistance in navigating what, for them, could be a devastating energy transition. The West always wanted them for only one thing: their oil. China is offering give and take.
Vaguely interesting maybe, but is it really important? Yes, is the short answer. Dropping the decades-old oil-dollar link would diminish the dollar’s use for lots of other things, make it more expensive to finance the chronic and humungous US trade deficit, and severely undermine US prestige and power.
If Xi’s “new paradigm” goes through, the US will have to live less on credit and military swagger and support itself more by making things. Many Americans may say that sounds fine. But manufacturing is hard and dirty, and being forced into it is humiliating. Whether America can drop its credit addiction without political mayhem is impossible to say.
US All-Oil Offer
The dollar’s lock on oil trading goes back to the Petrodollar Agreement of 1974 between the US and Saudi Arabia. When the Saudis and other Arab oil exporters cut off oil to the US in retaliation for its support of Israel in the 1973 Yom Kippur War, oil prices quadrupled, with devastating economic effect. Soon a deal was struck to prevent a repeat and underpin the then-sagging US currency.
The US would buy Saudi oil and protect Saudi Arabia militarily. In exchange, the Saudis would trade oil only in dollars, buy US weapons, and recycle surplus dollars back into the US financial system, including Treasury bonds. Not coincidentally perhaps, the mid-1970s was the last time the US exported more than it imported. It began living on credit, as a strong dollar made US goods relatively expensive, contributing to factory closures.
This continued until the 2008 financial crisis, when doubts were sewn about the dependability of the US financial system just as the Shale Revolution was picking up momentum, reversing a long decline in US oil production. Soon after came the energy transition. The US no longer needed much Saudi and other Mideast oil.
The Saudis still bought US weapons, but Americans grew tired of fighting Middle Eastern Wars, and many in the Mideast grew resentful and doubtful of the dependability of US military “protection.” China became the global growth center for oil from the Gulf Arabs and their top competitor, Russia — even as the Chinese built an immense solar equipment manufacturing sector and began making batteries, wind turbines and electric vehicles (EVs). The dollar remained the lead currency for trading oil and most other things, but due mainly to a lack of alternatives.
A big reason for disaffection with the dollar was that Washington got more and more trigger-happy with “unilateral sanctions” on countries it found irritating. The most notable were major oil exporters Iran and Venezuela, but the list grew to 20 or more countries. An extreme version of US sanctions prevents a country’s banks from using the international financial clearing system known as Swift (Society for Worldwide Interbank Financial Telecommunications).
American politicians love hurling sanctions around because it allows them to look tough but doesn’t cost “US taxpayer dollars” or put US soldiers “in harm’s way.” The rest of the world generally hates sanctions because they appear arbitrary, ignore international norms, and in their extreme form, allow for no recourse even for third countries that simply want to trade with nations the US targets.
The Iranians became adept at slipping around Swift, and the “Brics”– Brazil, Russia, India, China and South Africa — looked into alternatives to the dollar for various uses. But little actually happened. Until Russia invaded Ukraine, followed not only by Moscow’s effective eviction from the international trading system but also blocking of Russia’s access to its own foreign reserves that were held in dollars and Euros.
That last US step put real spring into previously slow-moving efforts to develop substitutes for the dollar in oil sales and international trade generally. China now pays for Russian oil in its own yuan, bypassing Swift. Russian oil also is flowing freely to India and Turkey. India reportedly pays in its own rupees or in dirham, the currency of the United Arab Emirates (UAE). You’ll soon see why.
China’s All-Energy Counteroffer
Just how important all this is came into sharp focus with Xi’s December visit to Saudi Arabia, where he also met with rulers or other royal figures from the UAE, Qatar, Kuwait, Oman and Bahrain, the Saudis’ fellow Gulf oil and gas exporters; the presidents of Egypt and the Palestinian Authority, the prime minister of Iraq and others.
It was a big, friendly affair with none of the prickliness that marked Joe Biden’s humiliating visit a few weeks earlier with the Saudi Crown Prince, whom the US president had spurned earlier due to the prince’s widely assumed ordering of the 2018 murder of Washington Post journalist Jamal Khashoggi.
As noted in an opinion piece in the Dubai-based Gulf News: “For the Arab states China’s growing markets, investments and its growing technological prowess are of considerable interest. And above all China’s engagement with the Gulf states or others are not saddled with demands of political morality and is based on sovereign equality.”
Xi presented “a new paradigm of all-dimensional energy cooperation.” Echoing the old US Petrodollar pledges, he said China will buy “large quantities” of oil over the “long-term” and take payment for it in Chinese currency on the Shanghai futures exchange. In addition, “The two sides will work more closely on clean and low-carbon technologies involving hydrogen, energy storage, wind and [solar] photovoltaic power and smart power grids, as well as localized production of new energy equipment.”
Xi also spoke of strengthening “investment cooperation” in the digital economy, “peaceful nuclear” technology, “big data and cloud computing,” 5G and 6G technology, aerospace, and “language and cultural cooperation.” He proposed China and the Arabs “deepen digital currency cooperation and advance the m-CBDC Bridge project.” M-Bridge was a pilot sponsored by the Bank for International Settlements (BIS) to create a block chain ledger for making “multi-currency cross-border payments in central bank digital currencies (CBDCs),” to quote the BIS itself. The pilot ended in October and was deemed a success.
Guess who participated? The central banks of China, the UAE, Hong Kong and Thailand. That’s the same UAE whose currency India is using to pay for Russian oil. An important thing about CBDCs is that they bypass Swift and everything to do with dollars — thereby undercutting Washington’s financial sanctions’ power. Hmm.
While most of Wall Street was dozing, Zoltan Pozsar — a managing director in the investment department of Credit Suisse, former advisor to the US Treasury and Federal Reserve, and free thinker — did an almost line-for-line analysis of Xi’s speech. Pozsar forecast that there will indeed be a “new paradigm” between China and the GCC, similar to Beijing’s existing relations with Russia and Iran.
This means China would hold the equivalent of a mortgage on much of the world’s oil. That in turn means China will have cheaper energy than Europe and US allies who stick with dollar-pricing, Pozsar says, with resulting higher inflation and loss of industry.
What Beijing wants is to topple US financial hegemony and its ability to enforce sanctions — not to replace the US in any direct sense. China’s leaders saw that the US style of global financial management encouraged US companies to invest abroad and rely on cheap imports paid for with borrowed money to keep consumers (voters) happy. This destroyed its domestic manufacturing sector and impoverished many of its citizens. They apparently want to avoid a repeat.
Who Gets Helped, Hurt
What even Pozsar brushes over too lightly in my view is the New Energy aspect of Xi’s offer. Unlike most Western countries, China has complementary short- and long-term energy policies. Short-term, it is keeping domestic coal mines going and lining up favored access to oil, even while building out the world’s largest vertically integrated solar manufacturing sector, and making wind turbines, batteries and EVs, which now account for roughly one-third of all its auto sales.
The Arab states, meanwhile, are desperate to diversity their economies while there’s still demand for the oil that supports them. Both Saudi Arabia and the UAE have recently been trumpeting ambitious solar and wind schemes. Renewable electricity can be generated incredibly cheaply in these sunny and windy desert countries. They are also on the hunt for other means of making money to replace oil income.
For China, these countries offer a potentially huge outlet to help compensate for likely shrinkage in Western demand for its solar equipment as the US and EU build up their own manufacturing. And if the renewables buildout in the Gulf is rapid enough, Beijing can also make good on Xi’s offer of “localized production [in Arab countries] of new energy equipment.” All the investment possibilities Xi listed are custom-designed to quench Arab thirst for economic diversification.
Not only does Xi’s offer appear to present a genuine example of the “win-win cooperation” his government touts so widely, it would also be good for the environment. Explosive growth in Arab Gulf electricity demand, including for desalinating immense amounts of sea water, has piled on CO2 emissions over the last decade.
The knee-jerk instinct is to assume that the US will be the big loser. For most Americans, though, would it be so bad not to have responsibility for care of the Middle East? What with wars the US itself started there, wars it has been dragged into, and the legacy of the 9/11 attacks, the relationship hasn’t exactly been a happy one. Nor would it be such a terrible thing if the US had to find somebody other than Opec to regulate its oil prices while it phases out the fuel.
The problem, to return to the beginning of this story, is the loss of reserve-currency status for the dollar and the enormous low-cost borrowing power that goes with that status. Americans are starting to see how destructive that addiction has been, but it’s still hard to kick the habit of cheap consumerism. Psychologically, any adjustment will be complicated by a loss of global prestige and accusations of sellout and leadership failure that are likely follow.
Navigating that shift without succumbing to fascism and/or starting a war will not be simple for the US, and success is not guaranteed. But that’s a topic for another day.
