Wednesday, January 6

Three analyses of Saudi Arabia's stumbling economy and the riyal's dollar peg

From The Wall Street Journal; Jan 5, 2016: Pressure Grows on Saudi Arabia to Ditch Dollar PegForward contracts surge to 16-year high this week seen as sign of increasing strain on the peg
In recent months, two oil-rich nations also have abandoned their dollar pegs.
Azerbaijan scrapped its peg to the greenback in December and its currency quickly lost half its value. Kazakhstan, another economy dependent on natural resources, let its currency float freely in August and saw it lose more than a quarter of its value in one day.
China has also moved to devalue the yuan since the summer as it grapples with slowing economic growth.
“The last year has shown us that when economic fundamentals change, pegs break,” said Peter Kinsella, an emerging-market strategist at Commerzbank in London.
From The Washington Post;Jan 4, 2016: Saudi Arabia has a giant mess on its handsThe next casualty in Saudi Arabia's oil price war might be its own economy.
There is no free lunch here, but there is a better way. That's devaluing its currency. The important thing to remember, as economist Lars Christensen points out, is that even though Saudi Arabia gets paid for oil in dollars, it pays its people in riyal. So there are two ways for it to earn more of its own money: for the price of oil to go up against the riyal and everything else, or for the price of the riyal to go down against oil and everything else. The first one isn't happening, so the second one is all that's left. That would give Riyadh the riyals it needs to keep paying the same amount of benefits — no spending cuts necessary — albeit in riyals that aren't worth as much as before.

In other words, inflation would do the job that austerity is now. That might not sound like much, if any, of an improvement, but here's why it is: The deficit would disappear and the economy would keep growing. And with half its population under 25 years old, Saudi Arabia needs that so it can give people jobs if it can't give them as much welfare. That's the reason other oil-dependent countries, like Azerbaijan and Kazakhstan, have already given up their dollar pegs, and why markets are beginning to bet that Saudi Arabia will be next.
You can only defy economic gravity for so long.
Pundita; Jan. 6, 2015:

Ah, but Saudi Arabia isn't Azerbaijan or Kazakhstan. It's the axis on which the pricing of oil in U.S. dollars turns. If Al Saud lets go of the dollar peg, other oil producers will follow; there will be a falling dominoes effect that will destroy the reasons for continuing to price oil in the USD, which is as much saying it will destroy the current international monetary system. Would this abandonment be a good or bad thing for Saudi Arabia and the rest of the world?

A close look at the system shows it was subverted years ago. This happened first when an increasing number of oil-importing governments were able to cut deals with oil producing governments that allowed them to circumvent purchasing dollars to pay for oil; they were able to pay in their own currency. 

This wasn't exactly a shadow system because it was on the books. But a real shadow system emerged after sanctions were slapped on a major oil producer, Saddam Hussein's government. This prompted the government to undertake a large operation in illegal oil trading that reached many parts of Asia and even into Europe.

There were penny-ante players as well, stealing enough oil from pipelines in the Middle East and Central Asia to finance their entry into additional illegal activities. Thus, the skyrocketing rise of 'black' globalization.  These players were also willing to accept oil payments in local currencies but it was Hussein's government that industrialized the illegal oil trade from the wellhead -- a trade in oil that wasn't pegged to the U.S. dollar. 

Sanctions against Iran, another major oil producer, produced another major entrant in the illegal oil trade.  

Upshot: An increasingly significant portion of currency trades was a money laundering scheme that governments used to hide illegal oil purchases. It also meant that the oil trade, as a predictor of economic trends, became irrational. Much oil production was being double-counted -- first the actual oil produced, then some of the same oil was stolen and sold -- or production was greatly underestimated to hide massive theft.          

It also meant that the shadow currency trade system, like the shadow banking system that rose along with it, was out of the reach of regulators. That meant there was no way to buffer shocks. The international monetary system began lurching from one crisis to another but no matter what regulators did the patches didn't hold.

It was as if the source of a water leak eluded the plumber; he knew there was a crack somewhere in a maze of pipes but the question was where.

Enter Islamic State.

To be continued.


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