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The Tide of Commerce

Rapid economic growth outside the United States over the past two decades is also undermining the dollar's importance.

In 2009, China pushed past the United States to become Africa's biggest trading partner. In 2012, Chinese-African trade exceeded $200 billion.

Inconveniently for the dollar, much of the trade is energy related. China gets one-third of its oil from Africa and is very engaged in the African petroleum industry. Examples:

• In 2006, China purchased a 45 percent stake in a Nigerian offshore oil and gas field for $2.3 billion.

• In 2010, it made a $23 billion agreement to build three oil refineries and a fuel complex in Nigeria.

• In 2013, Sinopec Group agreed to buy Marathon Oil's 10 percent stake in an Angolan offshore oil and gas field for $1.52 billion.

• In 2013, the China National Petroleum Corporation (CNPC) acquired a $4.2 billion stake in a Mozambique offshore natural gas field.

With those deals comes growth in the use of Chinese currency in Africa. In January 2014, Nigeria's central bank said it would sell U.S. dollars to increase its yuan holdings from 2 percent of total foreign-exchange reserves to 7 percent. A day later, Zimbabwe's central bank announced that it would add the yuan to its roster of official currencies.

Russia and India are close to a major energy alliance. In March 2014, Rosneft CEO Igor Sechin visited India to discuss cooperation between Rosneft and India's state-run Oil and Natural Gas Corporation (ONGC). Rosneft announced it had agreed to ship gas to ONGC from Rosneft's yet-to-be built LNG plant in Sakhalin, on Russia's Pacific coast. It's a virtual lock that dollars will not be involved.

An additional factor is the rise of consumerism in the large developing nations, like China, India, and Brazil. As at-home demand for goods rises, it tends to have a stabilizing effect on the indigenous currency, and nations that see increasing exports to these countries are more apt to switch their business out of the dollar.

Then there's gold, the historical choice for stability in times of financial turmoil. In 2009, as the U.S. Federal Reserve was churning out new dollars at an unprecedented pace, the world's central banks turned into net gold buyers (after years of selling off their reserves). The year 2013

Saudi Crude Oil Exports by Destination, 2012

Figure 11.1 Saudi Crude Oil Exports by Destination, 2012

Source: Energy Information Administration. © Casey Research 2014.

saw record buying of gold in China and Russia, as well as much of the developing world, led by Iraq and Brazil.

Germany's Bundesbank has put on the noisiest demonstration of interest in gold (which is to say, interest in securing an alternative to the dollar). In 2013, it sought to repatriate 300 metric tons of gold it had stored in the vault of the New York Fed. A Bundesbank spokesperson said the relocation was "in case of a currency crisis."

Back to Riyadh

The dollar's hold on its reserve status now depends on the petrodollar system, which in turn depends on Saudi Arabia. And the Kingdom of Saudi Arabia is increasingly looking eastward.

As noted, Iranian oil is important for China—9 percent of China's imports. But oil from Saudi Arabia is even more important; the Saudis send 19 percent of all the oil China imports. (See Figure 11.1.)

Trade between Saudi Arabia and China has increased almost 58-fold in the past two decades, from $1.28 billion in 1990 to $74 billion in 2012. Saudi Arabia has been China's top partner in the Middle East for 11 consecutive years. The two countries just keep growing closer. In 2012, they agreed to build the world's largest refinery on Saudi soil, a joint venture worth $8.5 billion.

In 2009, Saudi exports to China exceeded those to the United States for the first time, and the country now exports three times more to five Asian countries (China, Japan, South Korea, India, and Singapore) than to Europe and North America combined. All this—along with the United States' shale revolution and its decreasing need for imported oil—points to China as the growth market for Saudi petroleum.

Saudi Arabia is not the only Muslim power to have deepened its economic ties with China over the past decade. Egypt, Indonesia, Iran, Iraq, Kazakhstan, Malaysia, Mauritania, Nigeria, Pakistan, Sudan, and Turkey have done so as well. But Saudi Arabia has gone the furthest.

The Chinese and Saudis are still using dollars in their trade, but for how long is an open question. Saudi Arabia is not likely to pull the plug anytime soon. American guarantees to support the monarchy in case of insurrection and defend it against invasion still carry a lot of weight. With Shi'ite Iran and newly minted (though besieged) Shi'ite Iraq on Saudi Arabia's doorstep, that protection remains critical.

But Saudi/American relations are cool at best. There's a lot of irritation in the relationship for the kingdom. For instance, the United States has beaten the "democracy" drum in the Middle East since 9/11, which has not been pleasing to the distinctly undemocratic ears of the Saudi monarchy.

Saudi officials view U.S. post-Cold War hegemony in the Middle East as destabilizing in its overall effect. Saudi Arabia sees itself as suffering for reckless and poorly executed American foreign policy. The United States toppled Saddam Hussein against Riyadh's advice, and now Iraq threatens to come apart. Plus, the U.S. government continues to fail to pressure Israel to make the concessions to the Palestinians required under the Saudi Initiative of 2002.

The Saudis saw the U.S. decision to remove Saddam as wrong-headed from the beginning, knowing that any democratically elected national Iraqi government would be Shi'ite majority and open to cooperation with Iran. Thus when the Bahrain protests erupted in 2011, the Saudis did not wait for a permission slip from the White House before sending troops to assist in a harsh crackdown to defend Bahrain's Sunni monarchy.

Saudi Arabia views American officials, and particularly the Obama administration, as clueless about Middle Eastern realities. The unfolding of the Arab Spring has led many in Riyadh to question Washington's loyalty to the kingdom and its allies. When protests erupted across Egypt in 2011, the Saudis were disappointed at the passivity of the Obama administration as a strategic partner of 30 years (the Mubarak regime) disintegrated. Washington's subsequent decision to reduce military aid to General Sisi has further irked the Saudis, who fear Sisi's enemy, the Muslim Brotherhood.

Many Saudis also accuse the United States of betraying the anti-Assad rebels in Syria, and Riyadh was angered when the Obama administration decided not to strike Assad's forces after their alleged use of chemical weapons.

And there is Iran itself. Barack Obama has made conciliatory gestures toward Iran virtually from the beginning of his presidency. While sanctions remain the stick, Riyadh sees negotiations with Iran as an overly generous carrot. From Saudi Arabia's point of view, the whole process signals a possible shift in the regional balance of power that would leave the kingdom exposed.

The Saudis do not, therefore, see U.S. negotiations with Iran as a positive. They see them as a slap to Riyadh's face, and yet another reason to question Washington's commitment to the kingdom.

Putin, who was the first Russian leader ever to visit Saudi Arabia, in 2007, sees it all unfolding. He recognizes that Saudi participation in the proposed Double Eagle payments system or something like it would make dethroning the U.S. dollar much easier.

Saudi Arabia has kept holding its hand out to Russia, specifically by offering a $15 billion arms contract to the Russians if they will soften their support of Assad. Russia won't rush a decision that big, but with the United States pulling back on involvement in the Middle East, it's only a matter of time before Saudi Arabia and Russia begin working together more closely, most likely starting with a weapons deal. But it won't happen quickly, as Saudi Arabia is a supporter of the Islamic State of Iraq and the Levant (ISIL) and most of Assad's other enemies, while Russia is Assad's ally.

Before it happens, China will already have a close relationship with Saudi Arabia, as it is rapidly advancing in that direction. And because China and Russia are now working so closely, the Chinese-Saudi relationship will help to draw Russia closer to Saudi Arabia.

Much will depend on Saudi Arabia switching away from the petrodollar, but in the meantime, it will be in Saudi Arabia's interest to play with both sides, the United States and the Sino-Russian axis. Rather than standing with the United States or jumping ship, Saudi Arabia will take a middle path, which will be enough to give Putin the opening he wants.

It is still a matter for conjecture, but at some point the Saudis may decide two things:

• First, that by not dealing more forcefully with Iran and Syria, the United States has reneged on its promise to keep the monarchy safe, so Saudi Arabia has no reason to continue honoring its part of the 1973 petrodollar agreement.

• Second, that using U.S. dollars in every transaction is foolish, an unnecessary bit of overhead, especially in dealing with the Chinese.

If these ideas take root and Russia presents itself as a reliable protector, the Saudis will ditch the buck, and Putin's work will be done.

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