Upending the dollar hegemony

Once Saudi, Russian and Iranian oil are denominated in yuan, Beijing will dominate 40% of oil market

Beijing is launching a yuan-denominated crude oil futures market that may soon eclipse the hitherto dominant US dollar-based Brent and West Texas Intermediate (WTI) exchanges. In an additional challenge to the dollar’s role as the global reserve currency, the new “petro-yuan” will be convertible into physical gold at the Shanghai and Hong Kong gold exchanges.

China had shrewdly plotted the dollar’s dethronement for years. While less than one per cent of New York’s COMEX transactions are converted into physical gold, the Shanghai Gold Exchange, operationalised in April 2016, offers full convertibility for the yuan. 

The petro-yuan plan, originally pencilled in for launch in 2018, was accelerated due to the continued weakening of the dollar, setting the stage for the appreciation of a historically undervalued yuan. A stronger yuan will attract more gold to Shanghai and Hong Kong. 

More significantly, the petro-yuan will enable oil exporters such as Russia, Venezuela and Iran to bypass US sanctions by trading yuan for gold. Earlier, attempts to peg oil to the yuan flubbed as China lacked sufficient diversification in its domestic petroleum infrastructure. This threshold has since been crossed, along with official gold stockpiles, which have risen from 395 tonnes in 2000 to 1,828 tonnes in 2016.  

China’s gold-buying spree also coincided with massive bullion purchases by Russia’s central bank and India’s insatiable appetite for the shiny metal. According to a 2015 report by the World Gold Council, India’s estimated stockpile of 22,000 tonnes was worth over $1 trillion! 

Eurasian gold standard? 

Global traders will prefer the oil-for-gold deal instead of paper US Treasuries. Indian traders, with their historic propensity for gold, will be no exception. After all, Pliny’s two-millennia-old lament over the haemorrhage of Roman gold still echoes through the vaults of India’s ancient temples. 

Massive gold reserves can be wielded as trump cards during negotiations for preferential trade ties and defence technology transfers. India has so far failed to capitalise on this causal bonanza.  While New Delhi’s gold monetisation scheme  remains tardy, gold as a superconductor remains critical to next-generation industries worldwide. 

The RIC (Russia, India and China) nations, therefore, may be tempted to “weaponise” their gold holdings and simultaneously ring-fence the Greater Eurasian economy in the face of surging exogenous risks. China and Russia are coincidentally among the top three gold producers in the world while China competes with India in terms of annual gold consumption. 

The myriad potentials of a RIC-based geo-economic continuum, initially anchored on a gold-backed yuan, may have influenced China to concede to India’s demands with regards to Pakistani terrorism during the recent BRICS summit.  

Incentives and penalties

Mass participation in China’s oil futures market may effectively internationalise the yuan, bridging the chasm between offshore (CNH) and onshore (CNY) yuan, which traditionally hindered the currency’s mass appeal. 

Beijing’s petro-yuan strategy naturally includes incentives and penalties. Saudi Arabia — the lynchpin of the global petro-dollar racket — has seen Chinese imports slashed from 25 per cent in 2008 to 15 per cent in 2016. This reduction has been counterbalanced by imports from Russia and Angola, with the latter even elevating the yuan as a parallel currency in 2015. 

Due to self-defeating sanctions imposed by the West, China now pays for Russian oil in yuan that the latter uses to buy up Chinese goods and gold. The gold standard, abandoned by Richard Nixon in 1974, is returning to the international scene. 

Looming trade war 

A yuan-precipitated process of de-dollarisation may threaten the economic prosperity of the US allies. Europe may have to choose either continued obeisance to US foreign policy whims or monetary accommodation with Beijing.  

The Donald Trump administration is largely out of options here. It may retaliate against China’s perennial intellectual property infringements. However, any such action may prompt Beijing to offload $1 trillion in US Treasuries into the global markets and destabilise the US economy. With North Korea forming a morbid nuclear mise en scène to Washington-Beijing ties, open economic warfare may soon break out between both nations. 

This is Washington’s game to lose. China would not have risked challenging the dollar if not for serious doubts cast over declared US gold reserves of 8,000 metric tonnes.  Along with the ongoing fake news pandemic, it is becoming increasingly difficult to source non-conflicting economic data from the US.  

A 2014 report by the Brookings Institution even questioned the real state of the US fiscal gap: Was it $210 trillion, as calculated by renowned economist Laurence Kotlikoff, or $13 trillion, as claimed by the Congressional Budget Office? Three years on, few have dared to proffer a definitive answer. 

No amount of gold in the world can plug fiscal gaps of triple digit trillions!

Possible global fallouts

Saudi Arabia, whose treasury is being rapidly depleted by a ruinous war in Yemen; billion-dollar Wahhabi obligations worldwide; and rising domestic discontent due to welfare cuts, may have little choice but to trade in yuan.  China may sweeten Riyadh’s currency switch by buying a five per cent stake in state-owned Saudi Aramco through an initial public offering next year. 

Once Saudi, Russian and Iranian oil are denominated in yuan, Beijing will dominate nearly 40 per cent of the global oil market, inducing similar currency shifts in other commodity sectors.

If Saudi Arabia accepts the petro-yuan trade, however, its US security umbrella — amounting to more than $300 billion per annum — may be withdrawn, risking greater geopolitical instability throughout the Middle East and North Africa.  In hindsight, President Trump’s state visit to Saudi Arabia earlier this year now appears like a desperate attempt to prop a wilting petro-dollar. Riyadh, therefore, may cautiously apportion its crude sales in both the dollar and yuan for the foreseeable future.

Whatever the outcome, Asia should brace itself for turbulent times ahead and accommodate a gold-backed petro-yuan instead of paper US treasuries. At least until a wider gold standard appears on the horizon, perhaps in the form of a gold rupee, ruble or yen.

The writer is a doctoral researcher in risk foresight at Universiti Teknologi Malaysia