China and Russia recently signed a 40-year, $400 billion energy deal.
When thinking about this, there is one term to remember — fungible commodity.
This term doesn’t apply to things that people do, or use, for kicks. We’re not talking about “fun” commodities. Instead, fungible means something where units can be interchanged seamlessly.
A great example is the U.S. dollar.
Any dollar bill can be exchanged for another dollar bill without any drop in the value of the dollar, or any problems in using the dollar. This makes U.S. dollars fungible.
This is different than exchanging one U.S. dollar for the equivalent amount of another currency, like 102 yen. While the value might be the same, plunking 102 yen into a soda machine in the U.S. would not result in a soda. It would simply clog the machine.
On the flip side — providing dollars instead of using them — the fact that U.S. dollars are interchangeable can be very important as well. If a parent wants to give a college kid money for food, but not for beer, then the parent can give stern instructions on the use of the cash. However, the money can still be used for beer or, more to the point: any other money the kid would have used for food can now be diverted to beer.
I’m taking you through this to highlight how fungible commodities can be moved around, but at the end of the day, they all work the same. This is particularly true when it comes to energy.
Currency Markets and Commodities
For years, the Iranians have been saber-rattling about not selling oil to the U.S. That’s OK, because we’ve been boycotting Iranian oil since the hostage crisis in 1979. But neither action matters.
This is not to say that the hostage crisis wasn’t important, only that our reaction in the oil market didn’t do much.
That’s because, the day before the crisis, there were, say, 25 billion barrels of oil consumed per year. The producers of the same grade of oil, like Saudi Arabia, Kuwait, Iran, etc., would sell their oil to clients free to buy from any of them.
The day after the U.S. stopped buying from Iran, or Iran stopped selling to us, there was still demand for 25 billion barrels of oil, and there was still enough supply to satisfy that demand. The fact that the sellers and buyers matched up differently didn’t really matter.
The same thing will happen with Russia and China.
The Chinese have a growing appetite for energy, particularly natural gas. This isn’t a surprise to anyone. The Russians have one main export — energy… also not a surprise. The two even share a (very cold) border, and have been negotiating a large-scale energy package for many years.
The fact that a seller of a commodity and a buyer of a commodity have entered into an agreement isn’t concerning. What seems to cause consternation is that the Chinese will now buy so much from Russia, and Russia will sell so much to China.
But really that’s OK, because it means China won’t be buying as much from other sources, who can then sell to Russia’s old clients.
The issue that arises when it comes to natural gas is transportation. For Russia to get the product to China, it must invest a lot of money in infrastructure. At the same time, for Russia’s old clients (Europe, for example) to replace the flow of gas from Russia, it must also deal with logistics.
This adds an element of uncertainty to the calculation, but it doesn’t change the basic premise.
Could this deal be a U.S. dollar “killer”? No. It’s not quite big enough to do the job.
This agreement is supposed to be worth $400 billion over 30 years. More than $5 trillion worth of foreign currency transactions happen every day, and almost 90% of all currency transactions involve the U.S. dollar.
There is no doubt that the world will move away from the U.S. dollar eventually, but it won’t affect their status (one of the top three) in the currency markets anytime soon.
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