Are we seeing the end of the ‘petro-dollar’ system?

31 March 2022

David Jane
Premier Miton Macro Thematic Multi Asset Team

As we mentioned some weeks ago, the sanctioning of Russia via its exclusion from the Swift international payment system is one of the most important financial market consequences of the Ukraine conflict. While Russia has continued to supply the West with commodities, it has been unable to receive payment for these. Obviously, that is an untenable situation and has led to it retaliating in the obvious way.

Russia is now demanding that any ‘hostile’ states now pay for energy in Roubles. Some ‘non-hostile’ states such as India have already been buying energy in local currency, outside of Swift, via a direct Rupee-Rouble exchange mechanism. Europe is now faced with a very difficult choice, either suffer an energy shortage or buy Roubles to pay for the gas which is needed to power its economy. Either way, the sanctions appear to have potentially backfired.

This also has a profound effect on the global financial system. At present, almost all energy is traded in US dollar, a system known as the ‘petro-dollar’ system going back to the early 1970’s. This means that the US dollar acts as the world’s reserve currency as every nation needs access to the dollar and, therefore, holds dollars as part of its central bank reserves.

Trade in commodities in alternative currencies and the creation of an alternative payments system will have profound long-term effects on the world’s economies. Some of these effects are beginning to become apparent now. The true economic power of the producers of essential commodities has been masked by the use of the dollar for payments. Commodity producers and other exporters’ own currencies haven’t received the full benefit of their export surpluses, while the US has been able to run continual deficits, knowing that there is a natural buyer of US dollar. In particular, the Gulf states and China have built large holdings of US treasuries and have pegged their currencies to the dollar in order to stabilise their economies.

A post dollar world would have very different dynamics than the current system. The commodity exporting nations are likely to ‘de-peg’ from the dollar and their currencies will likely fix against commodities or baskets of commodities. Importing nations will need to buy these currencies in order to buy energy and raw materials. An obvious consequence is the strength of commodity exporting regions’ currencies. This is particularly so as we are in an era of resource constraints, partly, but not wholly, as a result of ESG driven supply constraints. The position of those nations that hold the balance of power in the resource markets has increased greatly over recent years and some at least are no longer happy to delegate that power back to the US. 

In fact, we appear to be moving into a multi polar world, where bilateral trade agreements replace the old global model. If currencies are no longer freely exchangeable, regions reliant on globalised trade such as Europe and Japan will have their status diminished. They will need to find a way of securing the foreign exchange necessary to buy their imports, rather than simply buying or recycling dollars received from exports. If bilateral agreements such as the Russo-Indian one become the norm, then these big, globalised economies will become, relatively, much weaker. This to no small degree explains the recent weakness of their currencies.

On the other hand, the US, which is primarily a domestic economy, will not suffer to the same degree as it is self-sufficient in most of its basic needs and trade is a surprisingly small part of its overall economy. Certainly, in the near term it isn’t being negatively impacted, although longer term the US will no doubt have to pay more for its borrowing or see a weaker currency versus the nations it imports from, notably China.

The full implications of recent events have yet to emerge, but it seems clear to us that you cannot simply undo removing Russia from Swift. While there will no doubt be push back, the end of the dollar based system is upon us. Indeed, several Gulf states have suggested they will consider non-dollar sales of oil going forward. The most obvious conclusion in our opinion is to continue to be heavily exposed to commodities and commodity producers and expect further rises in bond yields and inflation. Medium term we may find ourselves revising who we consider to be the economic winners and losers for the coming decades.

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