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The next crisis in the financial markets will not be caused by a shortage of reserves in the banking system, but by geopolitical shocks in the energy market. That's what Credit Suisse credit analyst Zoltan Pozsar writes in a new analysis. He expects that banks will not run into problems because of a shortage of reserves, but rather because of unsecured positions in, for example, precious metals. For example, in a scenario where Russia decide to settle oil in gold. What does Pozsar expect?
Pozsar explains in his analysis that the banking system is currently flooded with reserves, making a crisis in the repo market like the one in September 2019 much less likely. Central banks shrunk their balance sheets by taking reserves out of the banking system, causing them to fall below a critical threshold at one point. According to Pozsar, that critical limit is far from being reached, because banks are currently working every day more than $2 trillion of excess reserves at the U.S. central bank's Reverse Repo Facility (RRP). These are reserves that the market does not currently need and that the central bank can easily withdraw from the banking system.
In the run-up to the repo market crisis in 2019, banks faced an outflow of bank deposits, as companies had to pay taxes and at the same time the government withdrew money from the market with the issuance of a large number of new government bonds. This, combined with the low level of reserves in the banking system, led to problems in the repo market, according to credit analyst Pozsar. Banks did not have enough reserves to lend to each other, so the U.S. central bank had to intervene by injecting additional reserves into the banking system.
In a financial crisis, central banks can intervene by providing liquidity, but in a geopolitical conflict, their toolbox is very limited. Central banks may be able to print money, but they can no raw materials such as oil or grain. Or as ECB President Christine Lagarde said in February 2022: "With monetary policy, we can't fill pipelines with gas, clear backlogs at ports, or train more truck drivers."
And that's what makes the current geopolitical crisis so risky, because different rules of the game apply and power politics predominates. Pozsar cites the example of the oil market, where supply is controlled by a handful of players. The United States has used its strategic oil reserves this year to support Western economies and lower the price of oil, but it cannot continue to do so. With only 400 million barrels left in reserves, the lowest level since the 1980s, the U.S. will have to rebuild its stocks at some point. complement or reduce exports to, for example, Europe.
The tightness in the oil market is currently being carefully monitored by OPEC+, the oil cartel in which Russia also participates. The oil-producing countries within this cartel private cut production by 2 million barrels per day at the beginning of October to slow down the fall in oil prices. Much to the dismay of the United States, which wants a lower price to support the economy and replenish strategic stocks.
According to Pozsar, this impasse in the oil market may take a new turn as a result of Western sanctions, such as the price cap and the import ban on Russian oil. As a result, Putin is more or less forced to sell it elsewhere, because he does not want to sell oil below the market price to Western countries as a matter of principle. What he also won't want is for Russian oil to end up in the strategic oil reserves of the United States via other countries.
What can Putin do to strengthen his position? Russia could cut oil production to exacerbate the tightness in the global oil market and push up the price of oil, with the risk that other oil-producing countries will decide to increase production, take over Russia's market share and bring the price back down. It is an option, but it requires coordination and agreement within OPEC+.
According to Pozsar, Russia can also choose another and more daring strategy, which is to settle oil into gold. Putin may decide to offer oil for less than the price cap of $60 per barrel, provided the payment is made in physical gold: one gram of gold ($57) for a barrel of oil. Or even two barrels of oil for a gram of gold, to make it even more attractive to pay with.
What will happen then? Countries that want to import oil from Russia will first have to Buy gold, and then use it to pay for the oil. This effectively allows Russia to devalue the US dollar against oil. The Gold price will increase significantly due to increased global demand. The price could possibly even double from $1,800 to $3,600 per troy ounce, because who can't do without oil?
It may sound like an unlikely scenario, because the precious metal has not played an active role in international payments for decades. The last time this happened on a large scale was during World War II in Europe, when Switzerland acted as a hub for gold transactions between countries. Now the gold reserves are just gathering dust. Central banks buy Lots of gold, but they don't do anything with it. All international payments are made in dollars, euros and other currencies.
But aren't we now back in a kind of economic war, in which Russia and the Western world are diametrically opposed? Western countries froze Russia's foreign exchange reserves earlier this year and are now even considering them confiscation and give to Ukraine. Putin, in response to the freezing of Russian assets, demanded that gas in rubles As a result, the value of the ruble rose and that of the euro fell. Now the Western world is imposing sanctions on Russian oil, causing Russia to export its oil to Asia. This will not have been the last step.
In this geopolitical and economic chess game, gold may one day also be play a role. This has consequences for investors and banks that only own gold on paper or have hedged their position with paper claims on gold, such as futures contracts or options. Therefore, it is always preferable to have physical gold. This applies not only to central banks, but also to investors and savers.
This contribution was made from Geotrendlines
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