- China is now the world's largest importer of oil.
- It does not like having to make those oil purchase in U.S. dollars.
- As a result, China is using various techniques to encourage (forcing?) countries to accept the Yuan in oil transaction.
- If successful, it could mean the end of the U.S. petrodollar as the world's reserve currency of choice.
- This would be very bullish for gold.
In my Seeking Alpha article China's New Gold-Backed Oil Futures Contract Cuts Out The U.S. Dollar I explained how this new and recent development could cause massive disruption in to today's global oil market. But China isn't stopping there. The USA Today reports China is now using its status as the world's biggest oil importer to strong-arm Saudi Arabia to accept the Yuan in oil transactions. I think this is one of the most important and least publicized developments in the global currency markets.
Carl Weinberg, chief economist and managing director at High Frequency Economics, is taking the issue seriously because growing domestic production in the U.S. means that very shortly Chinese oil demand will dwarf U.S. demand. Weinberg says:
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.
This obviously has huge implications for the U.S. petrodollar. China's crude imports averaged around 7.6 million barrels a day in 2016. At $50/bbl, that equates to trading of an estimated $138 billion on an annual basis. For comparison, note the total market cap of the SPDR Gold Trust ETF (NYSEARCA:GLD) is around $35 billion. I mention that just as a comparison metric for investors to judge the potential impact if only 25% of China's oil imports were to trade based on this new futures contract.
Source: Nikkei Asian Review
And, as shown above, it is clear that China is intelligently diversifying its sources of imported, with Saudia Arabia making up only 12.5% of total imports during the first 6-months of this year. Meantime, Saudi Arabia's exports to the U.S. have dropped from over 2 million bpd in 2003 to a current ~1 million bpd this year:
Meantime, Russia is now the largest source of oil for China after some big energy and pipeline deals that I reported on back in 2013. These deals did not use the U.S. dollar.
Note that Russia, Brazil, and Venezuela alone accounted for around 25% of China's total oil imports (see graphic above). If Saudi Arabia capitulates to using the Yuan for oil trades, Middle Eastern exporters like Iraq and Iran would likely follow. That means that - very quickly - more than 50% of China's imports could potentially be non-U.S. dollar denominated transactions. If so, the impact would be huge. Over time it could erode the U.S. "petro-dollar's" role as the world's reserve currency of choice - and this would have a dramatic affect on the U.S.:
- The value of the U.S. dollar would likely fall significantly; imports would be more expensive, but it would also help U.S. manufacturing and exports.
- The U.S. Congress would very likely no longer be able raise the U.S. debt limit (i.e., print more U.S. dollars) indefinitely because global demand for the U.S. dollars will likely fall - perhaps dramatically.
- As a result, the value of gold, globally priced in U.S. dollars, would likely rise.
And of course oil - being the largest globally traded commodity - would likely have a big impact on the U.S. dollar being the world's reserve currency. Countries like China, Russia, India, Turkey, Brazil, and Venezuela have proposed using IMF "special drawing rights," or SDRs - which would be calculated daily from a basket of various currencies: the U.S. dollar, euro, Japanese yen, British pounds, and Chinese yuan - for international payments. Some have also advocated that precious metals like gold and silver also be components of any globally agreed upon SDR "basket." While the U.S. has been fighting such a move due to the obvious advantages of being the world's reserve currency (i.e. being able to raise the debt limit whenever it desires), ironically it may find itself need to support the idea of an "SDR basket" of currencies just to prop-up the US$ against the Yuan.
All this is obviously very bullish for gold. And when we factor in one of the most politically uncertain eras in U.S. history (see my 3-part series on Gold: The Possibility Of A Trump Induced Rally), I am amazed gold is currently trading under $1,300/ounce. Consider that we actually have a well respected U.S. Republican Senator saying out loud that Trump could be leading the U.S. onto a path to WWIII. An editorial in today's NY Times promotes the idea of barring the president from launching a first nuclear strike without a declaration of war by Congress.
Meantime, the administration's "tax reform" policy of giving additional tax breaks to the wealthy and corporations is believed to have dire consequences for the already blooming Federal debt. The Washington Post reports that the Republican party's tax policies are likely to add likely to add trillions to the deficit and relies on overly rosy projections of economic growth to minimize its budget impact. We've seen this game before. It is just the opposite of what the U.S. should be doing if one believes the days of the U.S. petrodollar dominating world trade could be numbered.
Summary & Conclusion
With U.S. crude oil exports recently hitting 2 million bpd, and growing, it is clear that if Saudi Arabia wants to keep its market share in China it will likely have to do so on China's terms: and that means accepting the Chinese Yuan instead of the US$.
The outlook for gold is the most bullish of my lifetime. All U.S. investors should allocate a portion of their portfolio to gold as an insurance policy against the very real possibility that the US$ could be dethroned as the world's reserve currency of choice. Whether it be the highly liquid GLD ETF or phyical gold bullion, U.S. investors should be taking steps now for the very real possibility that the days of the U.S. petrodollar are numbered. Regardless, I suspect we will see gold rocket to new all-time highs before President Trump leaves office.
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