I heard the romantic Beatle song, Getting Better, on the car radio the other day, and I sang along with them:” I have to admit it’s getting better – getting better all the time.” Upon reflection, I thought – I wish I could say that about the US economy. Instead, "I have to admit that it’s getting worse, and it seems like that it is getting worse all the time.”
Back on November 11, in my article So Long, Grandma, I wrote that “it will be hard to curtail inflation, and interest rates should remain high. Gold has probably already bottomed and should move higher; and although equities got a big boost from this week’s lower inflation number, it is hard for us to believe that equities can maintain a strong upward trend. Since then, the markets have acted much like we thought, with gold rallying close to 12%. During that same time period, the S&P 500 Index was up merely 1%. Unfortunately, in the past few weeks, the news has gotten worse, and it is very possible that this is just the beginning of extremely bad news.
When Joseph Biden was campaigning for President in 2020, he boasted how he would deal with the important oil producer Saudi Arabia: His plan, he said, “was to make the Saudis “pay the price and make them in fact the pariah that they are.” He gratuitously added that there is “very little social redeeming value in the present government in Saudi Arabia.” Then in October, 2022, he vowed to impose “consequences” on Saudi Arabia for teaming up with Russia to cut oil production.
The Saudi Kingdom isn’t exactly shaking in their boots. The bad news is that this past weekend, Saudi Arabia and other OPEC+ oil producers surprised the President by announcing further oil output cuts of around 1.16 million barrels per day; oil prices immediately jumped 6% the very next trading day. That price increase is obviously inflationary, and it will make it harder for the Federal Reserve to begin easing by reducing short term interest rates.
The really bad news concerns the US dollar. In some of our past articles (Dumping Dollars, Alphabet Soup), we warned of the danger that both China and Russia were enticing others to stop using the US dollar for international transactions. The danger is twofold. A reduction in the demand for dollars would lead to a lower dollar value, and that would mean more inflation as US corporations and citizens paid more for foreign products and services. More importantly, if foreigners reduced their ownership of US dollars, they would have less ability to utilize those dollars to purchase US Treasury debt. That indeed is starting to happen. In the latest release of Treasury data (January tic data of major foreign holders of Treasury securities) Saudi Arabia reduced its holdings by $8.7 billion (7.3%) in just one month. And China is continuing its sale of our debt. Their holdings dipped by close to 1% in January and are down almost 17% from a year ago. That’s not the last of the bad news!
On March 31, the democratic government of Brazil announced that it had reached a deal with China to trade in their own currencies, ditching the United States dollar as an intermediary entirely, China is Brazil’s biggest trading partner, with a record US$150.5 billion in bilateral trade last year.
Democratic India is the world's number three importer of oil, and Russia became its leading supplier after Europe shunned Moscow's supplies following its invasion of Ukraine. Indian customers have paid for most Russian oil in non-dollar currencies, including the United Arab Emirates dirham and more recently the Russian rouble. The transactions in the last three months total the equivalent of several hundred million dollars.
While we are not aware of any official announcement, you’d better believe that Saudi Arabia will soon be accepting Chinese Yuan, and not the US dollar, in payment for some of its oil. Saudi Arabia is China’s biggest supplier of crude, and China is the biggest destination of Saudi oil exports; and cooperation between the two countries is growing. Recently, Saudi Arabia significantly strengthened its energy ties with China by announcing a $3.6 billion deal to buy 10% of China’s Rongsheng Petrochemical, which would see it supply 480,000 barrels per day of crude oil to the company.
This cooperation between China and Saudi Arabia is not just confined to the oil trade. The Saudi Arabia's cabinet has just approved a decision to join the Shanghai Cooperation Organization (SCO), which is a political and security union of countries spanning much of Eurasia, including China, India and Russia. Formed in 2001 by Russia, China and former Soviet states in Central Asia, the body has been expanded to include India and Pakistan, with a view to playing a bigger role as counterweight to Western influence in the region.
Iran also signed documents for full membership last year.
Speaking of Iran, China has become its largest trading partner, and China has now used its economic clout and influence to broker a rapprochement between Iran and Saudi Arabia. All of this together will translate into a major loss of US influence in the important energy producing nations of the Middle East.
In the chart below, we depict the price action of gold, the dollar and the stock market since we published our So Long, Grandma article. As readers can see, gold has been volatile, while it has moved sharply higher. We expect that trend to continue, and we think the rally could actually accelerate. We believe the stock market will be locked in a volatile trading range, and we think we are closer to the top both in time and price. As for the US dollar, we won’t say it’s doomed, but the trend is clear. As the other nations of the world increasingly use other currencies for international trade, the ebbing demand for dollars will force its price down. This will support a higher inflation rate than the Federal Reserve wants, and that in turn, means that interest rates will stay higher and longer than most expect.
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