PIGS Don’t Get To Burn Oil

Posted by Jeff Rubin on May 4th, 2011 under SmallerWorldTags: , ,  • 12 Comments

With OPEC tapped out, where will China find the oil to power future economic growth?

The obvious answer is it will take a big chunk out of the 19 million barrels the U.S. economy burns every day. And China doesn’t have to build a blue water navy or engage in an arms race to take a big slice of the U.S.’s energy pie . All it has to do is stop showing up at the U.S. Treasury auction, and Washington’s massive budget deficit will do the rest.

Despite all the bashing China takes in Congress, it’s big bad China that finances Washington’s massive one trillion dollar plus budget deficit. It has for some time. Almost two thirds of the Peoples Bank of China’s $2.85 trillion foreign reserves are in U.S. dollar assets.

These investments have not been an act of benevolence towards U.S. taxpayers. China’s central bank felt compelled to become the largest holder of U.S. Treasury bonds to keep its Yuan from rising and undermining the competitiveness of Chinese exports in the U.S. marketplace. But that was in a world of cheap oil.

We live in a different world now. Not only will triple digit oil prices sever those trans-oceanic trade links through soaring transportation costs but they will throw the U.S. economy back into recession. Contracting economies, particularly those also burdened with huge fiscal deficits, don’t make great trading partners.

Without access to the huge pool of Chinese savings, the U.S. is no more capable of financing its fiscal deficit than the PIGS (Portugal, Ireland, Greece or Spain) are capable of financing theirs. If China stops funding the Treasury market, Treasury yields will soar, pulling mortgage rates with them.

The Federal Reserve Board could always respond by switching the printing presses to overdrive and monetize even more of Washington’s deficit than it is already doing. But the more money the Fed prints, the lower the value of the U.S. dollar, and the higher the US dollar-denominated price of a barrel of oil.

That just puts the price of oil that much farther out of U.S. motorists’ reach, while a soaring Yuan would give China’s motorists a big currency-adjusted discount at their pumps.

Alternatively, China’s exit from the Treasury market might just prod Washington into real action on cutting its deficit. But if that path is taken the actions needed to reduce the one trillion dollar budget deficit will become as much a yoke around its economy as the PIGS deficits are on their economies.

PIGS don’t get to burn 19 million barrels a day of oil because their economies are shrinking. If China wants to burn more oil, all it has to do is walk away from the U.S. Treasury auction and take what the U.S. economy will no longer be able to afford to burn.

  • Rojelio

    So if the US “goes to war” with China, like for example screwing up their oil investments in Libya, will the Chinese be paying for both sides of the conflict? Wouldn’t they have to lend us money to attack them? Or will the US just politely disassemble the military-industrial complex with barely a whimper due to lack of funding?

    Maybe our wise and patriotic politicians will start selling off our military assets just like they did with our manufacturing base so they can pay the tsunami of interest on our debt and China will take over as the world’s police?

  • Anonymous

    The conventional wisdom that I’ve always heard was China buys our debt because this is the singular place on the planet where banks and brokerages remain above water. Our Fed and Treasury sees to that. The scenario you’ve described could be held at bay or dealt with over time by serious commitment to changing our energy policy and reducing foreign imports.

    And if it isn’t China that buys our debt, it will be OPEC countries that continue to denominate their product in US Dollars that come to the rescue. It’s either that or their entire investment blows up.

  • RZ

    Would that not be the equivalent of a “casus belli”?

    As a result one or more of the following could happen:

    1) The rapid closing of the US market to China’s manufacturing industry, which could be extended to the wider Occidental World market;

    2) The convertibility of the US Treasury Bonds held by China could be reduced;

    3) A series of trade and/or security incidents could develop that would have for unfortunate consequence limiting the ability of China to import oil or coal or other strategic minerals;

    4) Regional conflicts could develop in Asia very close to China’s borders;

    5) Grave ethnic incidents could develop in some provinces of China that would destabilize it socially, economically and politically;

    6) Terrorists could succeed in lobbing a few nukes on Chinese cities from Pakistan…

  • Atkins TSX notes

    It seems to me that the Chinese should like to preserve a great American customer for their goods. At the same time, the Chinese can only spend their USD FX reserves on US assets, for if they sold the USD reserves to buy another currency, their remaining USD FX reserves would devalue. No, the Chinese will finance US hard assets of modern rail transportation infrastructure for example, and the oil saved from cars that come off the US highways will go to China. The constructors of the infrastructure will be the buyers of USD’s to protect the Chinese USD FX reserves value, while at the same time preventing the Yuan from appreciating too much. The American economy will benefit from the efficiency of modern infrastructure. The Chinese will get a toll on the infrastructure for a period of time. This is a win:win so we think it is more likely than the Chinese hurting a very valuable customer.

    I always enjoy JR’s perspective.

  • Anonymous

    In 2008 the ceiling was 147$/barrel. An earlier post predicted as high as 200$/barrel by June.
    I risked a top 125$/barrel in May before things started going south.

    Looking at the sharp declines of home prices and oil prices in the last few days it seems like I won the bet, if you can call being right in the middle of the double dip “winning”.

  • Rojelio

    Yeah, but the opposite argument that I hear people making is that if they allow their currency to rise and their purchasing power increases, then they won’t need all that investment in the US because they can rely on their own citizens to take the role of consumers. As an American, I hope you are correct. However, in order to make your argument, one must explain how is the US a valuable customer if they cannot pay back all of that treasury debt except by inflation?

    Secondly, the hard numbers from the Treasury department are that Chinese investment in US treasuries peaked in Oct 2010 and have been steadily declining since then.

  • oilwatcher

    Yupp…One day, Mr. Rubin will be right….just not this day…I think if he calls $200 oil for another ten years, his odds of success will increase.

  • oilwatcher

    Yupp…One day, Mr. Rubin will be right….just not this day…I think if he calls $200 oil for another ten years, his odds of success will increase.

  • Peter

    Natural gas we got to find a way to fuel our cars with it.

  • Abitibidoug

    That technology already exists. A car can be retrofitted to run on CNG (compressed natural gas), but it doesn’t have the range of a conventional petrol powered car. As petrol gets more expensive, the cost of the retrofit will be easier to justify. The future will probably include many short range vehicles, like taxi cabs, running on CNG as well as many dual fuel vehicles.

  • Global Warning


    I much appreciated your speech at ASPO in Bruxelles. We talked thereafter with you and Jean-Marc Jancovici about your view on inflation and barter with China.

    1) Here are some of the “special trades” I found with China. The new leading money is oil, not dollars …



    2) I really consider the Fed won’t raise the rates soon. Of course you are right it doesn’t mean the long term rate will not raise. But we could be in a weird situation with :
    a. Rather Strong inflation due to oil (around 5% as you mentioned ?)
    b. Low short term interest rates
    c. No second round inflation because of the output gap and high unemployement (in US)
    d. GDP plateauing
    e. So a net loss of purchasing power …

    3) Here is my view on inflation. It is non standard, and written in French ! As a Canadian, I hope you read French ? Your view would be appreciated.

    My conviction is that inflation is the only escape for OCDE long term debts.

    I hope we will keep in touch.



  • Unc

    Jeff,been out of the loop lately ,my comment is simple,he who has the gold makes the rules.Unc FSJ-B.C.