Gold-Backed Petro-Yuan Silliness: Reserve Currency Curse?

A massive amount of hype is spreading regarding China's alleged ambitions to dethrone the dollar. The story this time involves China's plan is to price oil in yuan using a gold-backed futures contract. Even if that were true, the impact would be zero. Nonetheless, CNBC is now in on the hype.

Yuan pricing and clearing of crude oil futures is the "beginning" of a broader strategic push "to support yuan pricing and clearing in commodities futures trading," Pan Gongsheng, director of the State Administration of Foreign Exchange, said last month.

To support the new benchmark, China has opened more than 6,000 trading accounts for the crude futures contract, Reuters reported in July.

Yawn.

Jeff Brown, president at FGE, an international energy consultant has a more accurate assessment. "Most counterparties will not want anything to do with this contract as it adds in a layer of cost and risk. They also don't like contracts with only a few dominant buyers or sellers and a government role."

Priced-In Madness

Repeat after me: It's meaningless what currency oil is quoted in. Once you understand the inherent truth in that statement, you immediately laugh at headlines like that presented on CNBC.

For those who do not understand the simple logic, consider the fact that one does not need to have dollars to buy oil. Currencies are fungible. In less than a second, and at any time day or night, one can convert any currency to any other currency.

If countries want to hold dollars they can. If one wants to hold Swiss Francs, Euros, or Yen they can as well. Oil likely trades in all of those currencies right now.

Countries accumulate US dollars because the US runs a trade deficit, and those dollars will eventually return to the US.

Currency Requirements

If China wants to assume the role of having the world's reserve currency, something I highly doubt actually, it will need to have a free-floating currency and the world's largest bond market .

Political Requirements

China will need property rights protection and a global willingness of countries to hold the yuan in order for the yuan to be the world's reserve currency.

Balance of Trade Requirement

Finally, China would have to be willing to run trade deficits instead of seeking trade surpluses via subsidized exports.

Please read that last sentence over and over again until it sinks in.

Mathematically, whether they like it or not, China and Japan have massive US dollar reserves as a result of cumulated trade surpluses.

Reserve Currency Curse

Having the world's reserve currency is a curse because it necessitates a willingness to have endless trade deficits .

Mathematically, as long as China runs surpluses, foreign holding of yuan will not match foreign holding of dollars.

A mathematical corollary to having massive trade deficits year in and year is the need to have the world's largest bond market.

Adding gold into the yuan-futures mix does not alter the picture other than to add costs.

Case Closed

The idea that the yuan will soon replace the dollar as the world's reserve currency is absurd for currency reasons, political reasons, and economic reasons.

Anyone who suggests otherwise understands neither currencies nor global trade.

Finally, given the implications of the reserve currency curse, I highly doubt China even seeks what these petro-yuan analysts claim.

Mike "Mish" Shedlock

Comments
No. 1-25
dgh
dgh

Some countries were recently locked out of the SWIFT system, Iran for example. In that case, getting dollars for oil made no sense because their dollars were not then fungible.

BoneIdle
BoneIdle

Anything who tells with certainty about China's future should be treated with extreme caution.

BoneIdle
BoneIdle

A recent article concerning China in the Weekend Australian newspaper contained 1000's of words. The only paragraph the made sense was the following quote :

BoneIdle
BoneIdle

A recent article concerning China in the Weekend Australian newspaper contained 1000's of words.

truthseeker
truthseeker

Mish I appreciate you showing me the compliment and all, but why do your seem like you're angry?

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