by Nick Giambruno, International Man:
Nick Giambruno’s Note: I recently spoke with my friend and colleague Chris Lowe about China’s new alternative financial system—and how it could mortally wound the US dollar. It was such an important discussion that I had to pass it along.
Chris is the editor of Bonner & Partners’ Inner Circle. His publication shares insights from Bill Bonner’s personal global network of analysts and investment experts.
Using force to compel people to accept money without real value can only work in the short run. It ultimately leads to economic dislocation, both domestic and international, and always ends with a price to be paid.
– Former U.S. Congressman Ron Paul
He who holds the gold makes the rules.
– Old saying
Chris Lowe: Why did you start researching the petrodollar system and its potential unraveling?
Nick Giambruno: This has been on my radar since 2006. That’s when Ron Paul, then a Republican congressman, spoke to Congress about the collapse of the dollar-based global monetary system.
As I recently told my Crisis Investing readers, I think it’s his most important speech ever. It’s called “The End of Dollar Hegemony.”
During the speech, Dr. Paul lays out why a global monetary order built around a fiat currency is doomed to fail.
Crucially, he pointed out the one thing that would precipitate the US dollar’s collapse—the end of the petrodollar system.
I recommend reading the speech in full. But this is the most important part:
The economic law that honest exchange demands only things of real value as currency cannot be repealed. The chaos that one day will ensue from our 35-year experiment with worldwide fiat money will require a return to money of real value. We will know that day is approaching when oil-producing countries demand gold, or its equivalent, for their oil rather than dollars or Euros.
I discussed this with Dr. Paul at a past Casey Research conference. He told me he stood by his assessment.
In a nutshell, he’s saying we’ll know the dollar-centric monetary system is on its way out when countries start trading oil for gold instead of dollars.
That’s already starting to happen.
Chris Lowe: To catch up real quick, why is the petrodollar at risk?
Nick Giambruno: Under the current petrodollar system, all global oil sales are made in dollars. However, the Chinese government recently announced a new mechanism that will allow oil producers anywhere in the world to trade oil for gold.
China’s new mechanism will totally bypass the US dollar and the US financial system… along with any restrictions, regulations, or sanctions from Washington. So for many oil producers, it will be much more attractive than the petrodollar system.
I call it China’s “golden alternative” to the petrodollar. Whatever you call it, though, it will allow for the large-scale trade of oil for gold, instead of dollars.
Here’s how it will work. The Shanghai International Energy Exchange is launching a crude-oil futures contract denominated in yuan, China’s currency. This will allow oil producers around the world to sell their oil for yuan.
Of course, the yuan is a fiat currency, just like the dollar. And most oil producers don’t want large stashes of yuan. The Chinese government knows this. That’s why it’s linked the crude-oil futures contract with the option to efficiently convert yuan into physical gold through gold exchanges in Shanghai and Hong Kong.
Chris Lowe: How soon will this new system be up and running?
Nick Giambruno: I spoke with officials at the Shanghai International Energy Exchange. They told me they plan to go live with it before the end of the year, or shortly thereafter.
Chris Lowe: But isn’t that a good thing? Isn’t gold, as a currency, more reliable than the dollar?
Nick Giambruno: I think it’s high time gold played a more central role in the global monetary system. The problem is ditching the petrodollar would negatively affect the US economy.
Think about it. If Italy wants to buy oil from Kuwait… or Argentina wants to buy oil from Brazil… they have to buy dollars on the foreign exchange market first.
This creates a huge artificial market for dollars.
It means the US can simply print dollars and exchange them for real things like French wine, Italian cars, Korean electronics, or Chinese manufactured goods.
It also helps create a deeper, more liquid market for US Treasury bonds. This pushes up prices… and pushes down yields… which allows the US federal government to finance enormous and permanent deficits.
The petrodollar has allowed Washington to spend astronomical amounts of money on welfare and other benefits for over half the population. This gives Americans a much higher standard of living than they would have otherwise. Most of them don’t know this or understand how it affects their everyday lives.
Thanks to the petrodollar, Washington can also sanction or exclude virtually any country from the dollar-based global financial system at the flip of a switch. By extension, it can also cut off any country from the vast majority of international trade.
Chris Lowe: Others have argued that this has led the US Deep State into military actions against anyone who threatens the petrodollar system. Is the Deep State that scared about the effects this could have on the economy and on its position as the world’s top power?
Nick Giambruno: Let’s put it this way, world leaders who have challenged the petrodollar system have ended up dead. Saddam Hussein and Muammar Gaddafi are prime examples.
In October 2000, Saddam started to sell Iraqi oil in euro only. He said Iraq would no longer accept dollars for oil because it did not want to deal in the “currency of the enemy.”
A little over two years later, the US invaded Iraq. After Baghdad fell to US forces, all Iraqi oil sales were switched back to dollars.
And thanks to WikiLeaks’ release of Hillary Clinton’s emails, we know that protecting the petrodollar—not humanitarian concerns—was the main reason for America’s involvement in the ousting and killing of Libyan leader Muammar Gaddafi.
According to the leaked emails, the US—along with France—feared Gaddafi would use Libya’s vast gold reserves to back a pan-African currency. This gold-backed currency would have been used to buy and sell oil in global markets. It would have likely displaced the CFA franc—a version of the euro used in 14 central and west African nations.
As I’m sure you recall, the US and France backed a rebellion that overthrew Gaddafi in 2011. After his death, plans for the gold-backed currency—along with Libya’s 4.6 million ounces of gold—vanished.
Chris Lowe: What’s Russia’s role in all of this?
Nick Giambruno: The dollar is not just a currency. It’s a political weapon… and Washington is not shy about using it.
Most recently, it tried to punish Russia for its actions in Ukraine by imposing economic sanctions. This made it harder for Russia to access the dollar-based financial system. So it’s no surprise that Russia struck a deal to sell oil and gas to China for yuan afterward.
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