A yuan-denominated future oil contract could be an historical game changer.
A future oil contract is one where you buy a certain amount of oil for a future date. Since Monday, March 26, future contracts have started trading at the Shanghai International Energy Exchange. The Exchange is in a free trade zone which means that foreigners can trade on that market as well.
Some say it’s the end of the Petrodollar while others say it won’t be able to compete due to the ease with which the Chinese government interferes with free markets, especially one where there is a lot of speculation that you never lack in oil markets and because the Yuan is a government-controlled currency.
Nevertheless, we have to see this from a realistic investment perspective. The petrodollar won’t disappear, but if China—which is the largest global customer for oil—manages to bend the market at least a bit, the dollar will definitely see increased competition from a new and rising economy and currency. Chinese companies can now buy oil without feeling the risk of fluctuations in foreign currencies.
So, where is the game changer here? Well up until now if you wanted to buy oil, you had to have U.S. dollars, thus buy the U.S. denominated IOUs. Now, if the market slowly turns to the Yuan, there will be less demand for the dollar and thus the actual value and image of the reserve currency will slowly weaken over time.
Some have been putting fake news out that the petro-yuan will be backed by gold, but I haven’t been able to find any official source so that’s isn’t something to take as “official.”
What Happens If The Dollar Loses Its Dominance?
Given the increasing strength of the upcoming growth economies, it’s probable that the days of dollar’s absolute dominance are going to be in the rear view mirror soon.
This depends on many factors and no one knows the speed at which this will develop, but if China demonstrates financial stability to the world—something the Euro hasn’t managed to do—many might renounce the dollar and shift to the Yuan. Don’t forget that the population in Asia is 4.5 billion while North America has just half a billion people and Europe around 800 million.
Oil importers wouldn’t need to look for dollars to buy oil and oil exporters wouldn’t need to buy U.S. Treasuries with their excess dollars which would lower demand for the U.S. currency and increase interest rates and inflation. This would put pressure on deficits, the budget, consumer credit, mortgages, and lower the standard of living.
What To Do From An Investing Perspective?
The dollar is so intrenched in global trading that it will take time, but if China slowly—by building the One Belt One Road initiative, investing in Saudi Arabia, and increasing the connections with Asian countries and Russia—starts to take the cake away from the dollar piece-by-piece, the long term picture isn’t bright.
You know how these things usually go, nothing happens for a long time and then it all flips in a big sharp move as people panic and rush into the new hot investment or currency where regulatory involvement follows.
Given the budged deficits and the credit economy, I’ll just continue to say what I have been saying for a long time: be diversified and prepared for everything by having exposure to great assets globally, hard assets, commodities, and a bit of precious metals.
A Note On Trade Wars & Other Wars
Ray Dalio recently published an article discussing how the trade war jitters are most probably just a bluffing strategy and how the actual trade tariffs aren’t significant on a global scale. He expects that there will be some trade agreements that look like wins for the U.S. which the markets will like, so we might see a run up in the markets.
He concluded that we are certainly in a world where the U.S. dominance is over and the world will become multipolar. He hopes that the new Trump hardline hires won’t go into wars and says that in such times: “I believe that it is especially important to keep one’s portfolio liquid (to be flexible) and diversified (to not have concentrated risks).”