Petroyuan's Crash at Birth

The petroyuan has launched. Let's investigate its success or lack thereof, primarily the latter.

Economist and book author Daniel Lacalle pretty much sees things the way I do regarding the petroyuan hype. Lacalle compiled some amusing stats in his post on the Petroyuan’s Lacklustre Birth.

Crash at Birth

Every time I read that the yuan is going to dethrone the dollar and that China is going to monopolize the oil market in its local currency, I remember those films and reports of the late 1980s predicting the imminent Japanese supremacy and how it would absorb the West. Today, more than two decades later, Japan continues in secular stagnation.

The biggest mistake made by China in its launch of the yuan oil contract has been to think that a currency with capital controls and an expensive market that trades for barely a few hours a day would be a fantastic incentive for global oil transactions.

Key Stats

  • It is monstrously expensive: more than twice the cost per lot compared than US dollar ones. The transaction fee for Shanghai futures is about $3.20 per lot, compared with about $1.50 for U.S. oil contracts, according to Bloomberg.
  • It is not “backed by gold“. China’s total gold reserves are a fraction of its money supply (less than 0.007%) and if the yuan collapses, the nascent “Petroyuan” falls with it. The mirage of thinking that the yuan is guaranteed by gold reserves is only comparable to Flat Earth theories.
  • It trades for only a few hours. One hour and a half in the morning, one hour and a half in the afternoon and a few hours at the close of the Chinese market. While the rest of the international oil contracts have twenty-four-hours trading, the Chinese local currency energy market (INE) trades eight hours a day. The implantation and internationalization of a currency does not happen because it is decided by a government
  • It has excessive margin requirements, more than double those of the equivalent markets in US dollars. The margin required to participate in China’s futures is 7% of the contract value, rising to 10 percent the month before delivery and 20 percent in the last three days before delivery. In the U.S., the margin is 3.4% of the contract value, according to Goldman Sachs and Bloomberg.
  • To the above, we must add two other barriers. A translation exchange to other currencies of 3% and, above all, an economy that has capital controls in which the Chinese government can decide by decree if you can or cannot get your money back when it pleases you.
    The petroyuan is born fatally wounded because it tries to copy the mistakes of the Petrodollar with higher costs and tighter political restrictions.

No Success Story For China

I agree with every point above made by Lacalle with one possible exception. I am unsure if China thought it would be a huge success.

For China it is a matter of pride to have the exchange at all. If one wants to label that a "success" be my guest.

Death of Dollar Silliness

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

I wrote about this many times previously including this October 25, 2017 take called Gold-Backed Petro-Yuan Silliness.

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. CNBC is now in on the hype: China has grand ambitions to dethrone the dollar. It may make a powerful move this year.

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.

  1. Currency Requirement: 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.
  2. Bond Market Requirement: If China wants to assume the role of having the world's reserve currency, it will need to have the world's largest bond market.
  3. 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.
  4. Balance of Trade Requirement: 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 accumulated trade surpluses.
  5. Reserve Currency Curse Requirement: 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.

China flunks five out of five requirements for taking over the role of having the world's reserve currency.

Petroyuan Success

Curiously, the petroyuan is a success story, not for China but rather for the US.

Here's the short version: The huge irony in all the petroyuan hype is that it is a direct result of forthcoming US energy independence. That's a US achievement, far bigger than the symbolic gain by China.

Mike "Mish" Shedlock

Comments (7)
No. 1-7
SherWat
SherWat

Agree because of 1, 2 and 3. Not so sure about 4 and 5 because didn't the UK run surpluses when the GBP was global reserve currency?

hmk
hmk

Didn't the US run a trade surplus in the 50-60s . They were the reserve currency then also. ?

Roger_Ramjet
Roger_Ramjet

03

Roger_Ramjet
Roger_Ramjet

I don't think that the purpose is to dethrone the US dollar, but rather to create alternatives to existing global trade architecture that the US controls. Other countries, including China, Russia and Iran understand that if they don't play by the rules imposed by the US, they will be restricted from global trade by being barred on global exchanges and international banking systems (SWIFT). I think that is why these alternative systems are being developed.

Blacklisted
Blacklisted

Alternatives are rightly being DEVELOPED because the current debt-based dollar system is coming to an end. Anyone not planning for a transition is an idiot. It is not the petroyuan that will kill the dollar reserve, it is the explosion of dollar-based debt around the world, and the exposure of massive govt fraud and corruption that will implode confidence. What happens to foreign balance sheets when interest rates and the dollar rise?

Since govt's NEVER proactively change, the rising dollar and rates will cause a sovereign debt default contagion that forces an emergency G20 meeting. An outcome will be a new global reserve system.

It's important to understand how past empires collapsed, and who is preparing for the coming collapse. In the coming decade, when the current system implodes, China can and will be ready to let it's currency float, expand its bond market, and enforce property rights and the rule of law. The likely reserve will be SDR-like, where the yuan has a closer weighting with the dollar, pound, yen, and whatever the euro becomes.

The big unknown is how totalitarian will govt's become as they try to save their perks and power, and what citizenry will stand up to their govt's oppression. Needless to say, we will live through interesting times (if we are lucky or prepared).

brainy
brainy

the math (to be required to run deficits) is simple:

  • if every producer SELLs in USD - every customer must BUY in USD.
  • so outside the US - there is a strong req - to have USDs for oil-purchases.
OkieNomics
OkieNomics

The Triffin paradox makes having the reserve currency as much a curse as a blessing; I don't think China wants it, they just want to level the playing field and avoid being hostage to the U.S. dominated SWIFT system.. Expect to see many international trades settled in XRP in the coming years. Interledger can replace SWIFT without any nation's approval and be vastly more efficient.