Metals Notes

How the Petro-Yuan Will Impact The U.S. Dollar

This past March, China launched trading of the yuan-denominated crude oil futures contracts. These are the first futures that have been listed on China’s mainland to overseas investors.

Given that China is the largest importer of crude on the planet, Asia Times called the launch of the petro-yuan a “geoeconomic game-changer.”

But what does this mean for U.S. investors?

For the first time, overseas investors will be able to access a Chinese commodity market. And to start, the U.S. dollar will be accepted for deposit and settlement, while several other currencies will be accepted for deposit only, according to the Times.

Will the Petro-Yuan Kill The Petro-Dollar?

Experts say there’s no reason to think the launch of the petro-yuan will immediately end the dominance of the petro-dollar, according to Pepe Escobar of the Asia Times. He writes that the end of the petro-dollar depends on many variables, with the most important being how China controls the global oil market.

Escobar also explains that one benefit of the petro-yuan for China will be that it will bolster the country’s efforts to invest in Asian and Middle Eastern infrastructure, particularly in Saudi Arabia.

But at some point, China will either tell or even force, according to some experts, the Saudis to accept yuan for oil, which experts say would put the petro-dollar at serious risk — as well as the U.S. dollar itself.

Last year, before the petro-yuan was launched, Carl Weinberg, chief economist and managing director at High Frequency Economics, told CNBC the following:

I believe that yuan pricing of oil is coming and as soon as the Saudis move to accept it — as the Chinese will compel them to do — then the rest of the oil market will move along with them.

Countries Bypassing the U.S. Dollar

In recent years, nations opposed to the dollar being the world’s reserve currency, such as China and Russia, have taken steps to try to abandon it.

Escobar notes that recently Russia and China have attempted to operate in a non-dollar environment when trading oil. Last year, China even launched a payment system in both currencies, which is used for Russian oil sold to China.

And CNBC reports that both countries have also increased their efforts to mine and acquire physical gold to diversify their assets away from the dollar, while also serving as a hedge if the U.S. dollar. In recent years, Russia has been the largest official buyer of gold, followed closely by China, according to Business Insider.

Ultimately, though, the foundation of petro-dollar system is OPEC and Saudi Arabia setting oil prices in U.S. dollars. Outside of the options we’ve discussed in this post, buyers still need U.S. dollars to purchase oil.

But China’s ultimate goal, according to Escobar, is to “break the system” — in other words, ultimately remove the U.S. dollar as the world’s reserve currency and replace it.

Creating a Gold-Based Petro-Yuan

As the yuan eventually becomes equal to the dollar in trade, experts believe China’s next move will be to establish a yuan to gold conversion rate, which would further impact the U.S. dollar.

This is crucial because it will allow China’s trade partners to convert yuan into gold without having to purchase Chinese assets or convert them into U.S. dollars. Escobar notes that countries facing U.S. sanctions such as Russia, Iran and Venezuela would be able to avoid sanctions by trading oil in yuan convertible to gold.

According to Seeking Alpha, China also understands that a rising price of gold threatens U.S. dollar role as the world’s currency reserve, and is thus keen to purchase large amounts of gold and help lead other countries to do the same.

When more countries begin to realize there’s a feasible alternative to the U.S. dollar is when things will really start to shift — and Escobar says that a mass switch to the yuan will “certainly spark a U.S. dollar crisis.”

The petro-dollar still reigns supreme over global markets, but it will continue to face challenges in the near future. Purchasing gold, particularly while it remains at artificially low prices, could serve as a hedge if and when the U.S. dollar ceases to be world’s reserve currency.