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. 1-25
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.