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 (33)
No. 1-33
wootendw
wootendw

For what it's worth, Jim Rickards has been predicting a massive devaluation of the yuan.

Mike Mish Shedlock
Mike Mish Shedlock

Editor

Devaluation of yuan possible - But I also think he backs the petro-yuan theory

Deucalion
Deucalion

it boggles me, that this simple truth eludes everyone everywhere. i mean cnbc and msm are idiots but for economists and uni profs to parrot otherwise just makes me shake my head....no wonder there is so much economic illiteracy.

pietro
pietro

uyuiiiiu

pietro
pietro

Sorry about that, was trying to see how to post. Anyway Deucalion, I put it down to the education system. Certainly here in the UK throughout all levels of learning students are taught factlets and given statements to regurgitate for exams. Actual understanding is not required and debate as to how real or true 'facts' (which in truth are often no more than opinion or assertion) are is actively discouraged. This is how you end up with 'experts' and 'professionals' that know a great deal but understand very little. I first noticed this applying to people younger than their mid forties back in the mid eighties.

FlyOver_Country
FlyOver_Country

Mish, spot on about what it takes to be a reserve currency. May I add two other criteria that I believe are also important, strong military presence and stable government. When the world is going to crap, what currency do people run to? The dollar wins the majority of the time. Of course folks would say gold but that’s another story.

GeorgeKaplan
GeorgeKaplan

Still no RSS feed? MAJOR step backward coming to the Maven...

Porschephile
Porschephile

I agree with the above on the reserve currency. China wants no part of issuing the reserve currency but the post does not mention the significance of the yuan oil futures market. China is the first or second most prodigious user of oil in the world. When China buys oil from Saudi Arabia or other middle east countries except Iran, they must pay in dollars. This creates significant demand for dollars which are then held as treasury bonds for reserves in the oil producing country. After 40+ years of the petro dollar middle eastern oil producing countries hold a lot of dollar assets. This makes them vulnerable to dollar currency risk as well as allows US to print many dollar units without worry of inflation/devaluation. These and other reasons make it attractive for oil producing nations worldwide to try to trade in and hold other assets besides dollars.

Porschephile
Porschephile

Sorry, wasnt through yet....

Porschephile
Porschephile

Now the key to the process is getting Saudi to accept Yuan for their oil. I believe this will happen because China is the major customer and they have pledged to buy some ARAMCO at likely an inflated price. Once Saudi accepts Yuan, the other middle eastern countries will follow. Now, no one probably wants to hold Yuan for long so China has a solution. The oil producing country can take their Yuan to the SGE and trade for physical gold which is a reserve asset. This allows these countries to hedge their dollar holdings and works toward evening the playing field with currency creation. The physical gold will not likely come from China's reserves but from the open market. Since physical gold is at least 1:100 against paper gold this physical gold demand will make the gold price rise significantly.

RonJ
RonJ

Reserve currency curse. "The dollar is our currency, but your problem." Rome was not built in a day, but still became eventually, the Roman Empire. China is rising. Not ready for prime time yet, but moving in that direction. As China changed after Mao, China will continue to change. Their day will come.

ikanair
ikanair

China: Oh shit, we got lots of dollar, what we going to with them? and the american is printing nonstop, Ahh... we can spend it all. Yes,yes, let buy resources. Wait.. even better lets "lend" these dollar away for "interest". Even better, put in condition, to borrow, chinese company have first dip in projects. Yayyyyy... we spend useless dollar, we get resource + business + interest . Let call this OBOR . hehehehe

milanolarry
milanolarry

If oil were priced in Yuan, the Chinese government could turn on their printing press and buy oil, just like what the US is doing now. The PBOC cannot print the greenback.

jivefive99
jivefive99

Looks like Mish and Jim Rickards are now at polar opposites on this China-Yuan-oil-gold thing, and it will be nice for one to win and one to no longer to need to be read, which will save a lot of time. :)

surfaddict
surfaddict

...as long as the Lambo & Ferrari dealership in Dubai accepts Yuan, then local wont have to trade his camel to gold vendor for dollars, too bad he has no skill or marketable labor to barter for besides Oil Derrick management of Pakistani labor

johnlocke445
johnlocke445

Mike, You are making two incorrect assumptions. 1. That China wants to throw their currency into the world reserve arena. 2. You are assuming the world oil sellers will automatically reject this petroyaun contract and they, in the future, will never change their mind. This is a slow process that takes time. As a matter of fact, I read that China will limit the trading accounts once they go live with the contract so as to get the bugs out of the system. China's goal is to get their proper share of yuan usage for oil sale contracts, not the lion's share that the dollar used to be. They have no interest in holding world currency status. It's natural, however, that over time the yuan will slowly replace many of the US dollar contracts which will cause immense inflationary pressure inside the United States. This is why I am buying gold and silver.

JonSellers
JonSellers

"Countries accumulate US dollars because the US runs a trade deficit, and those dollars will eventually return to the US." Yes, but countries hold on to those dollar reserves because they need to buy and sell dollars to stabilize the value of their own currencies relative to the dollar. Especially countries that have large dollar-denominated debts. Having large dollar-denominated debts and a falling currency relative to the dollar makes the debt more expensive. Which means greater austerity on the population and an unhappy populace.

SleemoG
SleemoG

The reason for the hype is that someone thinks they can make a buck off of it (the hype).

Bam_Man
Bam_Man

The US has "weaponized" the Dollar-based financial system.

Bam_Man
Bam_Man

China merely wants to be able to side-step the Dollar-based financial system, if/when they find themselves frozen out of SWIFT and FedWire for political reasons.

Bam_Man
Bam_Man

I don't believe these moves have anything to do with China seeking Reserve Currency status for the Yuan.

Stuki
Stuki

For spot buys, currencies are pretty much 100% fungible.But for trading in futures, as well as for engaging in hedging and other intertemporal activities, it does start to matter which currency prices are quoted in.

SMF
SMF

The same people who see China becoming King of the World are probably the same who stated the same about Japan 30 years ago.

truthseeker
truthseeker

Mish you know we've had this discussion before, as this is a serious problem that seems unsolvable, unless the whole world allows us to devalue the dollar a huge amount, enough so we could manufacture products as cheaply as they do in China and the rest of the world. Well we know that's not going to happen, but even if it did our companies would simply raise prices to get the earnings up, the stock up, and then wait till the end of the month to be able to pick the day when the stock was the highest, back date it, then exercise their options. Also in the past few years China has been unsuccessful in trying to buy one of our largest oil companies, and recently once again they were stopped from buying one of our microchip companies. They continue to buy US real estate and bonds, but with China, Japan, the Middle East and Europe owning 4,5 maybe even as much as 6 trillion dollars, I don't see how this ends well for America.

Mike Mish Shedlock
Mike Mish Shedlock

Editor

Michael {Pettis just pinged me "100 percent correct. And if you bother to get a currency converter on your iPhone you can price oil in any damned currency you please."

JonSellers
JonSellers

@truthseeker, "I don't see how this ends well for America." America is just a spot on the map. It depends on who you are. As long as you own a significant amount of capital and can move that capital anywhere in the world, and are willing to move to nice places, you'll be just fine.

AlexSpencer
AlexSpencer

Of concern is the future property rights protections (under the political requirements category) for the dollar. Now there are restrictions who you trade with, the manner of the trade ie. cash or account, how much cash you can hold physically without confiscation, and loss of any discipline in controlling debasement of the currency by the government. These things are making bitcoin and gold more attractive. Maybe yuan is not so attractive in these areas either but at the current rate of decay in US politics people should be looking for something better to use for trade.

FolkHero
FolkHero

I do not agree with Mish for two reasons: (1) If a Yuan/Gold based oil futures contract was indeed meaningless, why would China bother and make such big efforts to establish it and encourage sellers and buyers to use it? (2) It's true that you can convert any currency at any time in USD (at least as long as you have access to the Swift system which is controlled by the US) but someone STILL has to hold USD to settle those contracts at any point in time. This is artificially creating demand for USD which would not be there if oil was settled in another currency directly. Will it be enough to replace the reserve status of the USD? Highly unlikely but it is another piece of the puzzle.

truthseeker
truthseeker

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

BoneIdle
BoneIdle

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

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

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

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.