Struggling with inflation and a nasty balance of payments deficit, Richard Nixon shocked the world’s central banks in 1971 by closing the ‘gold window’ in which US dollars could be exchanged for gold at the Federal Reserve.
The greenback went into a tailspin but reasserted itself after Washington forged a crucial alliance with Saudi Arabia in 1973. The Americans offered military protection and in return the House of Saud guaranteed that its oil sales would be conducted entirely in dollars.
Other oil exporting nations followed suit in endorsing the greenback, ensuring that anyone wanting to buy oil had to buy dollars first. The petrodollar era had begun.
Today, crude oil is still priced predominantly in relation to Brent or West Texas Intermediate futures, both of which are denominated in dollars. So news that the Chinese are preparing to launch futures contracts for oil denominated in the yuan and convertible into gold is stirring another round of speculation on whether the petrodollar is in peril.
Earlier in September the Nikkei Asian Review reported that the Shanghai International Energy Exchange had completed testing on China’s first commodity futures contracts designed for foreign firms. But the trials were widely presented in the media as part of a broader push to convince the world’s oil exporters to rely on the renminbi for payment, after the Chinese launched a commercial channel with the Russians earlier this summer in which oil purchases will be made only in yuan.
They have been pushing for similar terms with the Saudis, although Riyadh has been cautious about breaking with the Americans in what would be seen as a hugely symbolic moment.
In the meantime the Chinese media says that Beijing is sending a message that producers who price their oil in yuan will be preferred. Significantly, the Saudis have been losing share, falling from 25% of China’s total oil purchases in 2008 to 15% last year. There has been a small increase in shipments this year, but it doesn’t come close to the surge in deliveries from Russia, which is now China’s top supplier.
The wider problem is that oil exporters are hesitant about accepting the yuan, seeing it as too illiquid. But to make the oil futures more attractive, the Chinese are making them convertible into gold.
Experts say that the target customers are countries like Iran and Venezuela, whose frostier relations with Washington might convince them to give the renminbi a try. “It is a mechanism which is likely to appeal to oil producers that prefer to avoid using dollars, and are not ready to accept that being paid in yuan for oil sales to China is a good idea either,” an analyst told Nikkei.
If the oil contracts come into wider usage they will be seen as a danger signal for the petrodollar. Yuan-denominated trading in oil could also weaken American geopolitical power and China’s critics are already warning that non-dollar deals will allow countries to circumvent Washington’s claims to jurisdiction beyond its own borders, helping countries to evade sanctions.
Progress in pricing other commodities in yuan has been solid rather than spectacular. While the majority of the world’s physical gold is now traded on the Shanghai Gold Exchange, the trading of ‘paper’ contracts is still heavily concentrated in New York and London. Shanghai is trying to challenge its international rivals by promoting its own yuan-denominated fixes as benchmarks for derivative contracts. Dubai was the first foreign exchange to use the renminbi-denominated benchmark for trading and Hungary is expected to do the same later this year.
Talk of the yuan unseating the dollar in the foreseeable future is fanciful, however. The greenback features in almost 90% of trades in the foreign exchange markets, more than 20 times the share enjoyed by its Chinese challenger. Its share of 65% of global reserves dwarfs the yuan’s 1% too. As the world’s largest importer of crude, perhaps China has the means to make more meaningful inroads. And if it can start to secure more of a shift away from the petrodollar, that will be bad news for the dollar itself. An American president announced the end of the era of ‘dollars for gold’, but a Chinese one will be hoping to call a halt on ‘dollars for oil’.
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