A Significant Step to Dedollarization

By: Ani Markova, MBA, LIFA, CIM, CFA • September 15, 2017 •

 China to Offer Gold-Backed Oil Futures

Recent reports have indicated that China is preparing to release a yuan-denominated oil futures contract that is convertible to physical gold. This will allow oil suppliers to settle sales of oil in RMB, rather than in U.S. dollars, and then convert the RMB into gold on Hong Kong and Shanghai exchanges.

Why is this significant? It is the latest salvo from China, seeking to remove the global reserve currency status of the U.S. dollar. China has quietly been laying the groundwork to implement this new non-dollar trade settlement instrument over the past several years, signing bilateral local currency swap agreements with different countries around the world. As a result, China’s largest oil suppliers will now be able to transact directly with China using these gold-backed oil futures.

 

The move is part of a broader strategy to reduce the influence of the U.S. and a direct challenge to the “petrodollar” system, which has been in place since the mid 1970’s. Since that time, oil (and consequently all other important commodities) has been traded in U.S. dollars and only in U.S. dollars. Oil producers then “recycle” these “petrodollars” into U.S. Treasuries, providing a major source of funding for the U.S.government. This process allows the U.S. to accumulate nearly $20 trillion in debt and as a result, entrenches the U.S. dollar as the world’s reserve currency.

Countries such as China and Russia have since sought to create an alternative infrastructure to the current U.S. dollar-dominated global monetary system, intensifying efforts to settle bilateral trade not in U.S. dollars, but in rubles and renminbi. In March, Russia’s central bank opened its first office in Beijing, while also preparing to issue its first RMB-denominated government bond. Meanwhile, China’s motivations have long been well-telegraphed. At the 2015 LMBA Bullion Market Forum, Chinese central banker Yao Yudong’s presentation was titled “The world needs a new reserve currency”1, where gold was described as a “super-sovereign reserve ‘currency’”.

 

The End Game

As we have been pointing out over the past few years, China has undertaken the slow path of gaining economic power by promoting its currency to be accepted in trade and recognized as a reserve currency. The accumulation of gold reserves and the creation of Shanghai and Hong Kong physical gold exchanges are some of the stepping stones in that direction. Last year was a significant milestone with the RMB being officially recognized as a reserve currency and the Bank of China securing bilateral currency SWAP agreements with 34 central banks around the world, creating the mechanism for trading and clearing RMB trades. In the context of this strategy, it is also not a surprise that China has outlawed crypto-currencies, which was just recently announced.

For gold, the introduction of a gold-backed yuan oil futures contract reintroduces gold into the global monetary system. Its inclusion in the contract is significant and necessary in order to appeal to oil producers who prefer to avoid using dollars, but are not yet ready to accept being paid in RMB for oil sales to China. This is a great illustration of the important role that gold has to play in the Chinese efforts to shift away from a dollar monopoly to a multi-polar monetary system, as gold convertibility helps to shore up investor confidence in the new system.

It is important to note that these changes are not going to occur overnight. While these developments are incremental, they have the potential to significantly change the way the world does business over the long-term. They also underscore the importance to “insure” any well diversified portfolio with exposure to gold and precious metals mining companies, given the yellow metal’s increasing prominence in this geopolitical tug-of-war.

In the short term, we continue to monitor the changes in global monetary and fiscal policies, as well as global economic activities that are expected to generate inflation. Geopolitics will likely continue to support the “safe haven” demand as well. We believe that gold is likely to trade in its new range of $1,300-$1,400/oz for the next few months.

 

For more information, please speak with your AGF relationship manager.

1 Source: LMBA Bullion Market Forum 2015.

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Published Date: September 15, 2017