HH The Yuan-Oil Future And Gold

"There can be little doubt that the introduction of the yuan-denominated oil future has been a major strategic step for China"

Trading in the new Shanghai oil future commenced last Monday, and on the first three days trading there were 151,804 contracts traded with a turnover value of 65bn yuan. It is the first futures contract listed on China’s mainland available to overseas users, putting them on the same footing as domestic investors. There are 15 benchmark contracts for different delivery dates between September next and March 2019.

There is little doubt that the Chinese government views this contract as an important development, with international commodity trading houses, such as Glencore and Trafigura, encouraged to participate. Furthermore, state-owned banks would have been on hand to ensure the necessary currency and financial liquidity is available.

The Chinese are likely to ensure trading liquidity continues to build in its new oil contracts before its oil suppliers routinely use them against physical oil deliveries. Presumably, this is one reason the first delivery date is in September, while actual shipment is never more than a month or so.

This contract goes head-to-head against the petrodollar and is the first serious challenge to it since its inception in the mid-1970s. The petrodollar was born out of the monetary chaos that led to the end of the Bretton Woods Agreement, when excess dollars in foreign hands were redeemed for gold. In that sense, being the first significant threat to the petrodollar, this contract could mark the end of a monetary era.

China does not intend to replace the petrodollar with its own currency, other than for her own energy and commodity imports. To put it into context, China imports about 8 million barrels of oil per day, mostly from the Eurasian continent, which compares with global daily demand of roughly 100 million barrels. China also produces her own oil to the tune of about 3.7 mbd, so if all China’s suppliers take yuan in payment, it leaves about 88% of global demand still being priced in dollars.

Therefore, there is for the moment little alarm in Western financial markets about this development. However, at the same time, US oil production is rising, and her imports declining, so even though the energy world is dominated by dollars, the relative importance between the US and China with respect to the international oil trade is rapidly shifting away from America.

Currency factors and the Triffin dilemma

The undermining of the petrodollar’s status, even though it is initially only at the margin, provides a weak background for the dollar. China’s trade surplus, coupled with the US trade deficit can also be expected to continue to put downward pressure on the dollar relative to the yuan. To an extent, this relative dollar weakness is expected to be offset by China’s selling of yuan for dollars in order to keep a lid on the exchange rate.

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Moon Kil Woong 11 months ago Contributor's comment

The dollar is already weak and that's the main reason for inflationary pressure, not labor shortage or strong economic growth. To counter this interest rates are being pushed up by the Federal Reserve and QE is being reversed. The issue is, if it gets bad they will use QE to buy up the excess Treasuries and then if demand doesn't pick up we are in trouble.

China will not destroy the dollar. We and our profligate Federal deficit spending will be the cause of a dollar unwind. The fact that others countries are looking for other currencies to store value is a symptom not the cause. China's currency aims are not the main problem mainly because no one wants to hold too much of it because it is not a free floating currency, China doesn't want to run mass deficits with a country so countries will be hesitant to hoard the currency for fear or repercussions, and there are trade restrictions.

Thus the US will remain the global trade currency, however, their ability to dump as much as they want in the global market will have further constraints as time goes on. It probably would be this way with or without China exchanging oil and gold futures in its own currency anyways.

Thus the message is clear. The US must realize their current behavior has consequences in the future and things will change with or without them changing. That said, we are ok for the foreseeable future although we could be in a much better position with lower, not higher deficits for one thing.