Why It Really All Comes Down To The Death Of The Petrodollar, by Tyler Durden

Good article about the death of the petrodollar and petrodollar recycling. The links in the article are also recommended. From Tyler Durden at zerohedge.com:

Last week, in the global currency war’s latest escalation, Kazakhstan instituted a free float for the tenge. The currency immediately plunged by some 25%.

The rationale behind the move was clear enough. The plunge in crude prices along with the relative weakness of the Russian ruble had severely strained Kazakhstan, which is central Asia’s largest crude exporter. As a quick look at a chart of the tenge’s effective exchange rate makes clear, the pressure had been mounting for quite a while and when China devalued the yuan earlier this month, the outlook for trade competitiveness worsened.

What might not be as clear (on the surface anyway) is how recent events in developing economy FX markets following the devaluation of the yuan stem from a seismic shift we began discussing late last year – namely, the death of the petrodollar system which has served to underwrite decades of dollar dominance and was, until recently, a fixture of the post-war global economic order.

In short, the world seems to have underestimated how structurally important collapsing crude prices are to global finance. For years, producers funnelled their dollar proceeds into USD assets providing a perpetual source of liquidity, boosting the financial strength of the reserve currency, leading to even higher asset prices and even more USD-denominated purchases, and so forth, in a virtuous (especially if one held US-denominated assets and printed US currency) loop. That all came to an abrupt, if quiet end last year when a confluence of economic (e.g. shale production) and geopolitical (e.g. squeeze the Russians) factors led the Saudis to, as we put it, Plaxico’d themselves and the US.

The ensuing plunge in crude meant that suddenly, the flow of petrodollars was set to dry up and FX reserves across commodity producing countries were poised to come under increased pressure. For the first time in decades, exported petrodollar capital turned negative.

Thus when Beijing moved to devalue the yuan, it drove a stake through the heart of the EM world by simultaneously i) validating concerns about weak Chinese growth, thus guaranteeing further pressure on commodities, ii) delivering a staggering blow to the export competitiveness of multiple emerging economies, iii) depressing demand from the mainland by making imports more expensive. Thanks to the conditions that resulted from the death of the petrodollar (e.g. falling FX reserves and growing fiscal headwinds), the world’s emerging markets were in no position to defend themselves against the fallout from the yuan devaluation. Complicating matters is a looming Fed hike. Included below is a look at flows into (or, more appropriately, “out of”) EM bonds. As Barclays notes, the $2.5 billion outflow in the week to August 21 is the highest level since February of last year

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