The Chinese and Saudi Arabian governments are trying to end the US dollar’s reign as the world’s reserve currency.
Officials are negotiating a deal that could allow buyers to pay for Saudi oil in the Yuan, Quartz reports. The Renminbi, or Yuan, is the currency of the People’s Republic of China.
A yuan-for-oil deal could be a fundamental change because the Saudis have only accepted US Dollars for oil since 1974. Hence, global markets set oil prices in US Dollars. That gave rise to the term petrodollar.
The Saudis and other oil producers use the dollar because the greenback is the world’s reserve currency. To explain, the reserve currency is the fiat currency financial institutions use for international transactions such as oil purchases.
Why they want Yuan-for-Oil
Governments, banks, investment banks, corporations, and other institutions hold large amounts of dollars so they can conduct international transactions. In particular, the Chinese, Japanese, and other governments buy enormous amounts of US government debt to ensure a supply of dollars.
Chinese companies could save money by paying for Saudi oil in Yuan. To explain, Chinese buyers could avoid the expense of converting Yuan to dollars and back. In particular, they could set up a direct digital payments system that allows Chinese to wire yuan to Saudi suppliers and Saudis to wire yuan to Chinese businesses.
Yuan-for-oil could help Chinese businesses by encouraging Saudi companies to pay for Chinese products with yuan. Hence, yuan-for-oil could give Chinese companies an enormous advantage when doing business in Saudi Arabia. That could be a good deal for Chinese companies and workers but bad for competitors such as Americans.
Additionally, the Chinese and Saudis could avoid English-speaking financial centers such as London, New York, and Singapore in the oil trade. Finally, third parties could sell goods for yuan in Saudi Arabia and use it to buy oil for export.
For example, a Swiss company could buy Chinese electronics with yuan and export them to Saudi Arabia. The Swiss could sell the goods for yuan and use the yuan to buy oil to sell elsewhere. The Swiss company could use Yuan because it can save money by not having to convert the yuan to dollars or Saudi riyals.
Mr. Market gives Swiss and other European companies an enormous incentive to use the yuan: the renminbi’s low price. One renminbi was worth 16₵ on 26 March 2022. Hence, the yuan gives buyers more buyers for their buck.
One immense advantage the Saudis will have is the ability to sell oil and buy goods with two major two currencies. For example, a Saudi businessman could sell oil in China for yuan, use the yuan to buy electronics. Then resell the electronics in the USA or South America for dollars.
Theoretically, the Saudi businessman could pay a lower price for the electronics by using yuan. Hence, a Saudi could make more money by paying for Chinese goods in yuan and selling those goods for dollars or euros.
Could the Dollar collapse?
I think Chinese officials are negotiating a yuan-for-oil deal because they are afraid the US dollar could collapse. To explain, the dollar’s status as reserve currency rests on America’s reputation for stability, technological prowess, power, wealth, and military might.
However, some serious cracks have appeared in America’s image over the past year. For example, the 6 January 2021 riot at the US Capitol raises the spectator of civil unrest and revolution in America. Similarly, America’s difficulty in dealing with COVID-19 and declining infrastructure raises doubts about US capability. Finally, the messy exit from Afghanistan shows the US military could be decaying.
My suspicion is Saudi and Chinese officials fear the dollar might not be available in the future. Hence, they want an alternative. My guess is the Saudis will try to negotiate rupee for oil, Euro for oil, Swiss Franc for oil, yen for oil, and pound sterling for oil deals next.
However, the Yuan for oil deal could be the biggest because China has the world’s second-largest economy. China had a gross domestic product (GDP) of $14.72 trillion, second only to the USA’s $20.89 trillion, in 2021, Global PEO Services estimates.
The People’s Republic could get enormous leverage with a yuan for oil deal because China had $17.204 trillion in purchasing power in 2022, Global PEO Services estimates. In contrast, the United States had $20.89 trillion in purchasing power in 2022.
Changing Reserve Currencies
I consider the yuan-for-oil deal a hedging strategy rather than a threat to the US dollar. Chinese officials want the ability to pay for oil and trade in over one currency because they are skeptical of the dollar.
I think investors need to be afraid because Chinese officials are skeptical of the dollar and the entire international financial system. I cannot blame them because of the chaotic events of recent years. For example, the COVID-19 pandemic, widespread civil unrest in the United States, and now all-out war in Ukraine and the threat of great power war.
Consequently, ordinary investors and speculators need to consider moving some of their money out of dollars. For example, into cryptocurrencies such as Bitcoin (BTC), Binance (BNB), or Ethereum (ETH) or a foreign currency such as the Euro, the British Pound Sterling or the Swiss France.
A Paradigm Shift in the Currency Markets
I consider a yuan for oil deal a paradigm shift in the currency markets. To explain, the People’s Bank of China (PBOC) will have to allow the Yuan to trade in the foreign exchange or FOREX markets under such a deal.
That means the yuan could compete with the dollar in international markets. Hence, Mr. Market will set the price of the yuan and have greater influence over the price of the dollar.
Notably, the yuan has been behaving like a safe-haven currency since the Ukraine War began, analyst Khoon Goh observes. A safe-haven is a refuge that money flows into times of crisis. I think Mr. Market views the yuan as a safe haven because the Chinese government is trying to stay out of the Ukraine War.
Being a safe-haven could help the yuan became reserve currency. For example, dollar started becoming a reserve currency when the US government stayed neutral in the opening stages of World War I and World War II.
Will the Reserve Currency Change?
To explain, the British pound sterling was the world’s reserve currency until 1940. However, the pound lost reserve currency status when Britain was in danger of German invasion in 1940. Earlier, the pound suffered heavily when the British suffered serious reverses in World War I.
By 1940, Britain was totally dependent on the United States for finance and war materials. Hence, the center of the world’s financial markets moved from the City of London to Wall Street. The reserve currency status followed the financial markets to the United States.
I do not think the yuan will gain reserve currency status unless the United States suffers a serious military defeat or political collapse. For example, Britain lost reserve currency status after the Fall of France in 1940.
However, the dollar and the yuan could soon trade equally in the world’s financial markets. That will be a fundamental change leading to a totally new market environment. In particular, it will reduce the dollar’s value and increase volatility and the risk of inflation or stagflation in the United States.
A New International Monetary System
Volatility could increase because Americans could have less buying power and the Chinese could get more buying power. Moreover, the value of dollar alternatives such as gold, cryptocurrencies, the yuan, the pound sterling, and the Euro could increase.
Thus, we could soon see the fall of the All Mighty Dollar and the rise of a new international monetary order. All speculators and investors need to watch the yuan–for–oil talks because they could lead to a new international monetary system.
Originally published at https://marketmadhouse.com on March 26, 2022.
