2a) PETRO-DOLLAR VS GOLDEN YUAN

We have highlighted in the previous presentation how the current state of turmoil in which the world seems to be mired (wars in the Middle East and the Ukraine, destabilisation in North Africa, severe austerity and near economic collapse in Southern Europe, accompanied by political instability caused by the so called ‘populist’ parties) can be read as the repetition of a historical pattern that signals the end of a paradigm of world economic and political governance.   Normally the end of a paradigm is brought about by the unravelling of its own contradictions, together with the challenge of a rival power (or coalition) to the incumbent hegemonic power.

In this presentation we will concentrate on looking at the challenge presented to the current hegemonic arrangement (dominated by the US and the West in general) by the rising economic and geopolitical power of China, in alliance with Russia and other mainly Asian countries.  Before we can concentrate on the challenge itself, we need to highlight the main features of the current system of world governance.

As it is widely known, American might used to rest on economic, political and military force.  While political and military force, although decreasing, remain very high, economic predominance has been waning for decades now, and it is coming increasingly under challenge.  However, for as long as the cornerstone of American financial power, the predominance of the dollar in the international monetary system, is still in place, no major change in the world system of governance is likely to happen.  In turn, the predominance of the dollar is based on two aspects:  its role as the main exchange and reserve currency for international transactions, and the ability of Wall Street and the City to attract capitals from the rest of the world (which allows the USA and to some extent the UK and the rest of the West to essentially print money to pay for their trade deficits).  With the financial collapse of 2008 western finance has become highly discredited, and it’s being kept on life support by continuous injections of Quantitative Easing, together with the lack of an alternative.  While the unreliability of the financial markets undermines the role of the dollar as a reserve currency, there is no escaping the current system for as long as the dollar remains the main exchange currency for international transactions (and for as long as there is no major rival reserve currency).  In turn, the predominance of the dollar as the main international exchange currency is based on its exclusive acceptance by most of the oil producing countries. This arrangement, called the petro-dollar agreement, is probably the main stumbling block that any country encounters when trying to build an alternative. The novelty of recent months is that the Chinese are in the process of preparing just that:  a gold backed, Yuan denominated futures contract poised to become a major benchmark for oil transactions.  Before we get to this Chinese challenge, we need to analyse how the petro-dollar was established and how it has been kept in place so far.  And even before the petro-dollar, we need to go back to how the predominance of the dollar (originally backed by gold) in the international monetary system came about in the first place.  This happened initially in 1944, at the end of WWII, of which the USA was the unquestioned winner.

The petrodollar system

The following is based on a talk given by Hank Sullivan in September 2016 and available on youtube with the title: ‘Geopolitics and the petrodollar – how the world really works’ (the relevant part is minute 25-59).

 In 1944 the Bretton Woods agreement established the dollar as the world reserve and exchange currency (meaning that international commodities were priced and sold in dollars).  This agreement, which gave the USA a distinct financial advantage, was made under the condition that the dollar would remain redeemable for gold at a consistent rate of 35$ per ounce. The USA promised not to print too much money but this was on the honour system because the Fed refused to allow any audits or supervision of its printing presses. The conversion into gold was meant to ensure a stable monetary system for the world.  In exchange for keeping monetary stability the USA was given the privilege to provide the world reserve and exchange currency. However, as it is often the case with monetary systems, the US policy makers did not manage to keep their privilege in check. In the years leading up to 1970 the rising social expenditures of Lindon Johnsons’ Great Society and the escalation of the Vietnam war made clear that the US waere creating a lot more money (also in the form government debt) than they had gold. As the US kept on creating money to pay for their trade deficits, their dollars kept accumulating all over the world and foreign countries started to go to the gold window of the Federal Reserve more and more frequently (in order to convert their dollars into gold), causing a rapid decline of the value of the dollar.  It became obvious that the Fed didn’t have enough gold.

The situation climaxed in 1971 when France attempted to claim its gold and the US refused.  On August 15th 1971 president Nixon made his famous declaration, announcing the temporary suspension of the gold window and promising a new international monetary system.  As it turned out, this was no temporary suspension but a permanent default.  Now the US had a problem: how to maintain an un-backed and debased currency at the helm of the international monetary system, indispensable condition to grant the continuation of their hegemony in the world. The solution was found in 1973, when President Nixon asked king Faisal of Saudi Arabia to establish the dollar as the only currency that Saudi Arabia would accept in payment for oil.

By 1974 the new system was in operation in Saudi Arabia. Kissinger went there and made a deal which effectively allowed the US, no longer able to back up the dollar with their own gold, to use for that purpose the Saudi’s oil instead.  The US could no longer back their currency with gold because they were no longer having trade surpluses but they had trade deficits instead, therefore they were losing gold rather than gaining it.  This, in turn, was due to the rising economic power of Germany and Japan.  Confronted with losing economic hegemony, the US decided to make the most of their still intact military, political AND financial hegemony in order to maintain their dominant position in the world. This was the essence of the deal that allowed the dollar to remain at the centre of the international monetary system:

  • In exchange for US protection of the Saudi oil fields the Saudis agreed to refuse all other currencies in payment. From then on all countries had to acquire dollars in order to buy oil.
  • The Saudis agreed to put their dollars in Wall Street banks and in the US Federal debt. This way the money created by the US for all the other countries would come back to Wall Street banks where it could be multiplied by creating yet more money in the form of debt  – and later toxic assets.  (Originally there was a fractional reserve banking system in place, then all the limits were removed and Wall Street went on a wild spree of toxic title creation). This arrangement over the years has provided huge amounts of funding for Wall Street and the US government deficit.

In 1975 the system became fully operative, as all the other oil producing nations of OPEC joined the deal and agreed to price their oil in dollars and to hold their surplus oil proceeds in US government debt securities in exchange for protection by the US. The system naturally spread to other commodities as well, all priced and sold in dollars.

This arrangement creates a huge demand in the world market for dollars, as all the nations wanting OPEC oil (and other commodities) have to keep dollars in reserve.  This allows the US to import goods simply by creating and borrowing currency into existence, and is known as ‘the exorbitant privilege’, after a phrase coined by the former French president Giscard D’Estaing.  All countries are forced to accept this system simply by the fact that they need oil.  This allows the US to have abnormally high trade and government deficits.  It is a wealth-creating machine and it is basically the modern equivalent of what in the past used to be colonial tribute.  The last year the US had a positive trade balance was 1974 – US trade deficits are on average 500 billion dollars a year.  This money sits in the accounts of China and other exporting countries at the Federal Reserve System as foreign reserves. If this arrangement came to an end all the dollars that have been created would come back to the US and their value would go down dramatically.

It is an unholy alliance between the Saudis (and other OPEC countries), Wall Street banks and the US government.  All three have a vested interest in the system.  The Saudis (but also anybody who holds dollar-denominated assets) want the value of the dollar to be high, as all of their money is invested in Wall Street and US Treasuries.  Therefore, if this arrangement is to work out, it is fundamental to ensure a reasonable amount of stability in the value of the dollar.  This was not easy to achieve at the beginning, it took some time before the US monetary authorities managed to reach this objective.

Following the agreement in 1975, OPEC countries started buying huge amounts of US Treasuries with their oil proceeds, causing their prices to rise. As the demand for US treasuries went up their yields went down.  In addition to lower yields, the depreciation of the dollar due to continued excess money creation induced the OPEC nations to raise oil prices in order to keep up with the falling value of the dollar.  This fuelled spiralling inflation in the world economy. This is how Yanis Varoufakis describes the phenomenon in the book ‘The Global Minotaur’ page 96:

Once the fixed exchange rates of the Bretton Woods system collapsed, all prices and rates broke loose.  Gold was the first: it jumped from $35 to $38 per ounce, then to $42 and then off it floated into ether.  By May 1973 it was trading at more than $90, and before the decade was out, in 1979, it had reached a fabulous $455 per ounce, a twelvefold increase in less than a decade.  Meanwhile, within two years of Nixon’s bold August 1971 move, the dollar had lost 30 per cent of its value against the Deutschmark and 20 per cent against the Yen and the Franc.  Oil producers suddenly found that their black gold, when denominated in yellow gold, was worth a fraction of what it used to be.

Therefore OPEC nations set about massively increasing the price of oil, in order to recover their declining earnings (in terms of gold).  In 1971 the price of oil had been 3$ per barrel.  In 1973 it jumped to $8 and $9, thereafter hovering between $12 and $15 until 1979.  The prices of all other commodities followed the same trend.  Therefore, having managed to maintain their position in the international monetary system thanks to the petrodollar agreement, now the US authorities needed to make it work by stabilising the value of the dollar.

To achieve this objective, in 1978 Secretary of the Treasury Blumenthal raised and pegged interest rates in exchange for OPEC to freeze oil prices.  In essence this was the deal: OPEC would stop raising their prices and the USA Treasury would peg the yield on its bonds so that OPEC would get a constant yield regardless of inflation.

However, something went wrong with this neat arrangement when in 1979 the Iranian revolution threw the Shah and BP out of the country and cut off production while nationalising the oil fields.  As a result, the price of oil rose sharply again and the USA resumed printing money to pay for the increased prices. This generated more inflation and frustrated the previous deal meant to stabilise the value of the dollar.

Eventually the new Governor of the Fed Paul Volker rescued the dollar for good, but at an enormous price for the real economy: by raising interest rates up to 15% to combat 13% dollar inflation and make reinvestment of petrodollars into US treasuries more attractive.  This is the slightly biased (in favour of asset holders, and disregarding the needs of the real economy) way in which James Rickards describes the ‘dollar rescue operation’ in his book ‘The New Case for Gold’ p. 42-43:

‘The dollar was rescued by Paul Volcker and Ronald Reagan beginning in 1981.  This is when the world moved to a new ‘dollar standard’, also known as he King Dollar period. In effect, the United States told the world that even in the absence of a gold standard, the dollar would be a reliable store of value.  This meant ending dollar inflation and making the United States an attractive destination for dollar investments. Volcker’s monetary policy and Reagan’s tax and regulatory policies accomplished these goals.  U.S. trading partners were essentially told they could anchor to the dollar.  The sound dollar standard was successful from 1981 to 2010, a period characterized by solid growth until 2007.”

While the problem of dollar stability was resolved by Paul Volcker and Ronald Reagan (and later by the complete de-regulation of the financial markets, in order to be able to keep yields high by creating yet more money in the form of toxic assets), the petrodollar agreement has presented another recurrent problem which has required frequent military intervention over the years:  the necessity to prevent OPEC countries from breaking away.

In 1980 the US decided to deal with Iran’s rebellion.  Supported by the US with money and weapons and by Kuwait with loans, Saddam Hussein’s Iraq invaded Iran, starting a war that lasted 8 years.  As a consequence, Iran oil production recovered. This was the way for the US to get back at Iran. The side effect was that Iraq became heavily indebted with Kuwait, which was also in the petrodollar system.  In June 1990 Iraq asked OPEC to increase oil prices but OPEC refused.  In August 1990 Saddam Hussein decided to invade Kuwait as a means to solve Iraq’s debt problem by annexing the country.  Then came the Desert Storm reaction by the US.

Fast forwarding to October 2000:  Saddam Hussein announces Iraq’s exit from the petrodollar agreement: from then on it would accept only Euros in payment for oil.  This was the kiss of death. In 2001-02 came the infamous allegations regarding the weapons of mass destruction and in 2003 the ‘coalition of the willing’ invaded Iraq.  In 2004 the Bush administration asked JP Morgan Chase to establish a new banking system in Iraq and of course the country went back to accepting the petrodollar in exchange for oil.

So far this is widely known recent history.  Now comes the trickier part, the part that has not received any media attention at all.  The post-invasion Iraqi new constitution, approved by the Iraqi Provisional Government headed by Paul Bremer, following the same pattern that has been extended, one way or the other, to all countries under American influence, required the establishment of an independent central bank. Independent is really a euphemism meaning that the bank would be privately owned, essentially controlled by the private banking cartel of the Federal Reserve.  So far, all that happened was according to plan.  But at some point the music started to change (presumably due to Iran’s influence on successive Iraqi governments).  After having privatised the central bank, in 2007, with the Iraq Oil Law, written by the US administration and submitted to the Iraqi parliament for approval, the USA attempted to privatise the oil reserves as well.  However, the Iraqi parliament never passed this law.  In 2014 it was still not passed, as the Iraqis have obviously no intention of giving away their oil fields to Chevron and Exxon, as they had done in the 25 years before the war against Iran.  Then the rebellion escalates.  In 2011 the Iraqi Supreme Court declares that the central bank cannot be independent and it must come back under the control of the Iraqi government – the country is obviously trying to re-assert its sovereign authority to govern within its borders.  This is not all, in 2011 another act of rebellion takes place: Obama fails to establish the ‘status of forces agreement’ as the Iraqis refuse to sign it. Basically the Iraqi government requires the US military presence to leave.  Therefore we have three important acts of rebellion: re-nationalising the central bank, refusing to privatise the oil fields and requesting the US military presence to leave.  The measure is full.

In 2014 ISIS mercenaries invade from the West, from Jordan, a very loyal ally of the US.  The Toyota pick up trucks full of ISIS mercenaries were unleashed to invade Iraq and Syria.  Al Maliki, the former head of the Iraqi government, openly accused Saudi Arabia and Qatar of inciting, encouraging funding and arming them. He said that these two countries are active in recruiting jihad fighters and luring them to fight.  There is evidence to this effect and, as the US, Saudi Arabia and Qatar were close allies until recently (2017), the US is obviously very much involved in the whole operation. In 2014 Russian president Vladimir Putin also joined his voice to these accusations.  Speaking to the Western press, he remarked that the West facilitates arms sales to the terrorists and a good press climate – in addition, he said – the West is doing nothing to stop the illicit oil sales that provide a good portion of the terrorists’ funding.  The bank accounts to which the oil money is flowing could be easily shut down, but nothing is being done in this respect.

This is only a sample of the most important military and covert operations carried out over the course of the years to maintain the petrodollar in place.  The point is that this arrangement is being enforced militarily upon the world.  The pattern is clear, as soon as a government decides that they don’t want to go along with the system, some kind of ‘regime change’ operation is put in place.

Another notable case is the case of Libya. In the words of Nick Gianbruno (blog article ‘The cardinal sin of international finance’ – December 2017):

Thanks to WikiLeaks realese of Hillary Clinton’s emails, we know that protecting the petrodollar –not humanitarian concerns- was a primary reason for overthrowing Libya’s Gaddafi.  According to these emails, The US (and France) feared that Gaddafi would use Libya’s vast gold reserves to back a pan-African currency.  The gold backed currency would have been used to buy and sell oil in global markets.  Also, it would have likely displaced a version of the French franc that’s used in Central and Western Africa.  The US and France backed a rebellion, both militarily and financially, that overthrew Gaddafi in 2011.  After Gaddafi’s death, plans for the gold-backed currency – along with Libya’s 4.6 million ounces of gold vanished.

The US haven’t had an easy life in the Middle East, as the debacles in Iraq and Afghanistan clearly demonstrate, but at any rate, they have managed to maintain the petrodollar arrangement in place, thanks to a relentless string of regime change operations.  However, in recent years a new and most formidable challenge has emerged.  It’s not coming from the Middle East but from the Far East, namely from China – with the help of Russia and other allies.  These countries combined might have what it takes to beat the system.  China has been quietly working for a long time to create a permanent bypass around the dollar.

The challenge coming from China: the gold backed Yuan

China has been building up its economic might over several decades now, using its cheap and disciplined labour force to lure transnational corporations to set up business in the country.  Over the years, this policy has allowed China to accumulate huge trade surpluses, to bridge the technological gap with the advanced world remarkably quickly, and to become a major player in the global markets.  For many years now, it has been quietly working to leverage its rising economic might, in order to carve a role for its currency in the international monetary system.  Achieving this would be a major turning point for China:  once acquired monetary hegemony a country can maintain a privileged position for a long time, as the case of the US proves very well.  In 1999 China opened the Shanghai futures exchange, in which trade, obviously in Yuan, has been growing ever since.  They trade gold and silver but also many other commodities of which they are the word’s main importer, such as copper, aluminium, zinc and led.  There is also a section of the exchange that deals with energy (it was opened in 2016).  China is the world’s n. 1 importer of crude oil.  In the meantime, China has been quietly selling off part of the US Treasuries accumulated as a result of its huge trade surpluses and converting them into gold.  This country now has a vast, and largely undisclosed amount of gold.  China’s official gold reserves amounted to 1,658 tons in 2015 but it is estimated that its real reserves may amount to around 4,000 tons, and possibly more. This gold has been acquired mostly in the last decade.  James Richards (in his book ‘The new case for gold’) estimates that China is aiming at a final target of roughly 8,000 tons, as this is the amount necessary to reach a 4 % gold-to-GDP ratio which, in turn, is the ratio required in order to become a major player in a reformed (or new) monetary system (this assumption is based on the ratio owned by the Eurozone countries combined which, at 4% of GDP, is the highest in the world).

After all this preparation, in September 2017 China has put into place the last piece of its monetary puzzle, by making possible the convertibility of Yuan denominated futures into gold.  What follows is based on these articles:

Diamon Evans – Nikkei Asian Review – 1st September 2017 – China sees new world order with oil benchmark backed by gold

Peter Schiff’s blog – 11th September 2017 – Gold backed, Yuan denominated oil futures could de-throne the petrodollar

Yutube video by Maneco64 – China delivers knockout blow to the petrodollar

The already mentioned Nick Gianbruno’s blog – December 2017 – The cardinal sins of international finance

On 6th September 2017 the Chinese authorities announced the launch of a gold-backed, Yuan denominated oil futures contract.  This move could be the decisive step to dethrone the petrodollar, as it potentially creates the most important Asian benchmark for crude oil, given that China is the world’s biggest oil importer. At the moment the main benchmarks are the Brent (for the international market) and the West Texas (for the US market) Intermediate futures – both denominated in US dollars.  The new Chinese futures contracts convertible into gold will allows oil exporters to avoid the dollar; however, as the Chinese are aware that most oil producers don’t want a large reserve of Yuan either, they have built into the contracts the possibility of converting them into gold. Basically an oil exporter can sell oil for Yuan in the Shanghai futures exchange, then go to the other part of the exchange (or to the Hong Kong gold exchange) and convert the Yuan futures into gold.  This does not apply only to oil, but to any other metal or commodity.  China has enough gold to honour these contracts, even if the transfer of physical gold should be requested by the oil exporting countries.   In general, very little transfer of physical gold is required in futures contracts, but in the case of China this is expected to happen more frequently. These contracts essentially make possible to trade oil for gold. It is a mechanism that is likely to appeal to oil producers that prefer to avoid using dollars, but are not ready to maintain large reserves of Yuan either.

Now the question is:  will this initiative be successful?  What volume of trade are these Chinese oil-futures likely to attract?  If China wants to establish the Yuan as a major international currency it needs many countries to join the system.  China has been working on this for quite some time now, first and foremost by strengthening its strategic alliance with Russia, the world largest energy producer.

In June 2017 China took the first step towards establishing the ‘petroyuan’ by launching a direct trade relationship with Russia in which the currency used is going to be the Yuan.  Already in 2014, in response to US sanctions against Russia in the aftermath of the Ukraine/Crimea crisis, China and Russia had struck a massive deal to trade Russia’s oil and gas for Yuan.  In June 2017 the relationship has been made permanent. Russia is the world’s largest energy producer and China is the world’s largest energy importer: two of the biggest players in the global energy market are totally bypassing the petrodollar system.  Many other countries could definitely be interested in sidestepping both the US financial system and US sanctions as well.

The attractiveness of these gold-backed, Yuan denominated oil futures contracts is that they allow oil exporting countries to avoid having large reserves of US or Chinese assets and to opt for gold instead, a very appealing reserve, highly liquid and with no geopolitical risks attached.  Therefore, these new contracts should be very attractive for a) those countries who simply want to get out of the US dollar/US Treasuries because they fear their value could come down any time, due to excess creation and b) those countries who want to get out of the dollar in order to escape US sanctions, such as – in addition to Russia – Iran, Venezuela, more recently Qatar etc…the list could increase (China itself could do without the continuous threats of being kicked out of the dollar system if it doesn’t crack down on North Korea).  In fact, Iran and Venezuela are already accepting Yuan as payment.  With the gold convertibility option recently launched, the list of countries that will come on board can only increase. However, there is one small problem:  as we have seen, getting out of the dollar can be the kiss of death…

China is doing its best to attract into its system as many countries as possible, but the main target, the game changer is Saudi Arabia, the world’s largest oil exporter.  Beijing, reluctantly, still has to pay in dollars for Saudi oil. Saudi Arabia won’t have it any other way because this would be the end of the petrodollar agreement and the consequences would be enormous.  For a start, the country would lose American diplomatic and military protection, along with the privilege of being sold very modern weapons by the US.  Then probably a media campaign would be unleashed against the undemocratic regime of Saudi Arabia.  Then who knows, regime change may follow…

So what has China been doing to overcome this formidable stumbling block? China has been indicating to oil producers that those happy to sell to them in Yuan will benefit from more business, with the consequence that the others will lose market share.  Beijing has been reducing Saudi Arabia’s share of its total imports, which fell from 25% in 2008 to 15% in 2016.  Chinese oil imports rose 13.8% year-on-year during the first half of 2017 but supplies from Saudi Arabia increased only by a tiny 1% in the same period.  Over the same timeframe, Russian oil shipments jumped 11%, overtaking Saudi Arabia as China’s top supplier.  Russia’s enthusiastic acceptance of Yuan as payment is the main reason for this shift.  Angola is another country that has been greatly rewarded for coming on board of the Yuan.  Angola went as far as making it its second legal currency in 2015, and jumped into second spot with an increase of 22% in oil exports to China in the same period.

The Saudis are between a rock and a hard place: they face either having to fall out of Washington’s good graces, or being squeezed out of the Chinese market, with the possible consequence of having to dump excess oil production on the global market, causing a reduction in oil prices that they can hardly afford, given the critical state of their finances.  The sheer size of the Chinese market makes it impossible for Saudi Arabia to ignore China’s demands, but they have to be extremely careful about ripping up the petrodollar deal.  We need to observe their recent moves, which indicate that Saudi Arabia may be in the process of very carefully paving the way for a shift in its geopolitical alignment.

  • Unexpectedly, Saudi King Salman in October 2017 became the first sitting Saudi monarch to ever visit Russia. Until recently this would have been unthinkable, as the two countries have been enemies for decades and they have been on opposite sides of the Syrian war.  The Saudi’s have committed to invest up to $10 billion in various Russian sectors.  Even more significantly, they have agreed to buy the S-400 missile system, Russia’s top line air defence system, as part of a $3 billion weapons purchase.  The Saudis have never bought Russian military equipment before, as they’ve depended on American military protection since the birth of the petrodollar.  The S-400 system is capable of deterring an American attack.
  • A few months ago (summer 2017) Saudi Arabia announced it was willing to issue Panda Bonds to finance its government deficit spending. Panda bonds are Yuan denominated bonds from non-Chinese issuers that are sold in China.  This is remarkable, as Saudi Arabia’s currency is pegged to the US dollar and they’ve always used exclusively dollars for their major financial initiatives.
  • The Saudis recently inaugurated the massive Yasref refinery in the Saudi city of Yanbu. It is an $8.5 billion joint venture between Saudi Aramco and China’s Sinopec.

These are noticeable steps, but something even more important is happening, which could be the actual game changer. In the coming months the Saudis plan to float a 5% stake in Aramco, the state-owned oil company.  They have been forced to this dramatic move (essentially selling off to foreigners part of their publicly owned oil company) by the dire state of their finances, depleted by the war against Yemen and by the oil price war of the last few years (itself interpreted by various commentators either as a commercial war against American shale oil or as a geopolitical war meant to keep Russian revenues low and destabilise Putin).  The oil price war seems to have come to and end precisely because Saudi Arabia has run out of money.  Having lost (or not having been able to win) these two wars, the Yemen war and the oil price war, along with having lost the Syrian war, another major game changer, is causing Saudi Arabia to have to seriously reconsider its geopolitical positions. The floating of a 5% (or possibly higher) share of Aramco, the most valuable company in the world, will likely be the biggest equity offering ever.  It could triple, or even quadruple, Alibaba’s current record initial public offering (IPO) of $25 billion.  Saudi Arabia needs money, but how much money can it get?  It will depend on whether or not big investors will show any interest.  So far Western investors haven’t shown a lot of enthusiasm.  For China, however, this is the perfect opportunity to buy political influence in Saudi Arabia.  If China bought a large stake in the Aramco IPO, it would help cement its relationship with Saudi Arabia and it would give the Chinese more leverage to compel the Saudis to accept Yuan for oil.  China is in the process of negotiating not just a 5% stake, but potentially a larger one.  Bottom line: the Saudis are broke and they need to drift towards the opposing camp…

If and when the Saudis agree to sell oil to China in Yuan, this will be the end of the petrodollar.  However, even short of that, the petrodollar system is facing serious erosion, thanks in large part to China’s golden futures.  Depending on how successful these gold-backed futures contracts are going to be, the rules of the global oil game may begin to change enormously.  This means that also the rules of the international monetary system will change.  The dollar won’t be as much in demand as in the past, therefore the interests on US Treasuries will have to go up in order to place them on the market.  As the US can hardly afford to increase their interest rates, they will probably have to inflate the currency to buy their own bonds, causing a dramatic reduction in the value (and attractiveness) of the dollar.  Either way, this will reduce the US government’s ability to spend, and hence its ability to wage war (overt and covert) around the world.  Losing part of their ‘exorbitant privilege’ will thus result in the decline of their hegemonic reach.  Does it mean that the dollar will soon go away?  No, this is not the end of the dollar, but only its reduction.  Instead of representing two thirds of world international reserves, as it is currently the case, it might drop say to 55% in 5 years, or 50% in ten years, who knows.

In addition to the implications for the dollar, the implications for the international monetary system are also potentially enormous.  For the first time since 1971 gold re-enters the system unofficially, as China is creating a de-facto gold backed Yuan.  This cannot be done in an official manner because China belongs to the IMF and the rules of the IMF ban the use of gold in the current monetary system.  Under the current rules only SDR’s (Special Drawing Rights) or the currencies recognised by the IMF are admitted as official reserve currencies.  Gold is banned as a reserve.  Currently you need 85% of the IMF vote to change the rules, and the US have 16% of the voting shares, giving them de-facto veto power.  China (with its allies) are in a situation similar to the one of a group of friends belonging to a club, say a golf club, whose rules they don’t like, but are forced to adhere to, for lack of an alternative.  What is happening is that they are building an alternative club.  They have been buying gold for quite some time, then they have founded the Asian Infrastructure investment bank, they have launched the New Silk Road infrastructure project, they have been creating the Shanghai futures exchange etc. etc.  They are building up an alternative club.  But at the same time they are not leaving the current one, as demonstrated by the fact that China applied for the Yuan to be included in the IMF’s basket of international reserve currencies, and this was granted in October 2016.  So what could happen?  Maybe in five or ten years time the Asian club will be up and running and will officially declare that they back their currency with gold and leave the US dominated system.  Or maybe the IMF will agree to make serious concessions and China and its allies will stay.  We could end up with two (or possibly even more) separate blocks, or with a deeply reformed unified system that is more egalitarian towards emerging countries. In the longer term we will probably end up with a Chinese or Asian dominated system.

For sure we are moving, as we speak, from a system dominated by the US and its allies to a system in which power is more equally distributed among two (or maybe more) different blocks, the Western block and the Chinese/Asian one. The situation could even polarise to the point of having two separate and hostile blocks, but in a very interdependent world maybe this is not likely. We will discuss the challenge to the current system coming from Asia-Pacific in more detail next time, along with the opportunities this situation offers for the progressive forces in the West, by weakening the neoliberal power establishment, which has been blocking human progress for a very long time.  From what we can see, this Asian block is opting for an expansive economic paradigm, similar to the one applied in the Western world after WWII.  This will probably re-open the possibilities for a Bretton Woods-style economic paradigm here in the West as well.  This will be the theme of the next episode.

Go to 2b) CHINA’S ASIAN DREAM – challenging the current world order