Gold-Backed Petro-Yuan Silliness: Reserve Currency Curse?

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. Nonetheless, CNBC is now in on the hype.

Yuan pricing and clearing of crude oil futures is the "beginning" of a broader strategic push "to support yuan pricing and clearing in commodities futures trading," Pan Gongsheng, director of the State Administration of Foreign Exchange, said last month.

To support the new benchmark, China has opened more than 6,000 trading accounts for the crude futures contract, Reuters reported in July.


Jeff Brown, president at FGE, an international energy consultant has a more accurate assessment. "Most counterparties will not want anything to do with this contract as it adds in a layer of cost and risk. They also don't like contracts with only a few dominant buyers or sellers and a government role."

Priced-In Madness

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.

For those who do not understand the simple logic, consider the fact that one does not need to have dollars to buy oil. Currencies are fungible. In less than a second, and at any time day or night, one can convert any currency to any other currency.

If countries want to hold dollars they can. If one wants to hold Swiss Francs, Euros, or Yen they can as well. Oil likely trades in all of those currencies right now.

Countries accumulate US dollars because the US runs a trade deficit, and those dollars will eventually return to the US.

Currency Requirements

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 and the world's largest bond market .

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.

Balance of Trade Requirement

Finally, 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 cumulated trade surpluses.

Reserve Currency Curse

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.

Case Closed

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

Anyone who suggests otherwise understands neither currencies nor global trade.

Finally, given the implications of the reserve currency curse, I highly doubt China even seeks what these petro-yuan analysts claim.

Mike "Mish" Shedlock

Mish you know we've had this discussion before, as this is a serious problem that seems unsolvable, unless the whole world allows us to devalue the dollar a huge amount, enough so we could manufacture products as cheaply as they do in China and the rest of the world. Well we know that's not going to happen, but even if it did our companies would simply raise prices to get the earnings up, the stock up, and then wait till the end of the month to be able to pick the day when the stock was the highest, back date it, then exercise their options. Also in the past few years China has been unsuccessful in trying to buy one of our largest oil companies, and recently once again they were stopped from buying one of our microchip companies. They continue to buy US real estate and bonds, but with China, Japan, the Middle East and Europe owning 4,5 maybe even as much as 6 trillion dollars, I don't see how this ends well for America.

Michael {Pettis just pinged me "100 percent correct. And if you bother to get a currency converter on your iPhone you can price oil in any damned currency you please."

@truthseeker, "I don't see how this ends well for America." America is just a spot on the map. It depends on who you are. As long as you own a significant amount of capital and can move that capital anywhere in the world, and are willing to move to nice places, you'll be just fine.

Of concern is the future property rights protections (under the political requirements category) for the dollar. Now there are restrictions who you trade with, the manner of the trade ie. cash or account, how much cash you can hold physically without confiscation, and loss of any discipline in controlling debasement of the currency by the government. These things are making bitcoin and gold more attractive. Maybe yuan is not so attractive in these areas either but at the current rate of decay in US politics people should be looking for something better to use for trade.

I do not agree with Mish for two reasons: (1) If a Yuan/Gold based oil futures contract was indeed meaningless, why would China bother and make such big efforts to establish it and encourage sellers and buyers to use it? (2) It's true that you can convert any currency at any time in USD (at least as long as you have access to the Swift system which is controlled by the US) but someone STILL has to hold USD to settle those contracts at any point in time. This is artificially creating demand for USD which would not be there if oil was settled in another currency directly. Will it be enough to replace the reserve status of the USD? Highly unlikely but it is another piece of the puzzle.

Mish I appreciate you showing me the compliment and all, but why do your seem like you're angry?

A recent article concerning China in the Weekend Australian newspaper contained 1000's of words.

A recent article concerning China in the Weekend Australian newspaper contained 1000's of words. The only paragraph the made sense was the following quote :

Anything who tells with certainty about China's future should be treated with extreme caution.

Some countries were recently locked out of the SWIFT system, Iran for example. In that case, getting dollars for oil made no sense because their dollars were not then fungible.