Oil for gold – the real story

by Alasdair Macleod, GoldMoney:

Following an article in the Nikkei Asia Review, which reported China will shortly introduce an oil futures contract priced in yuan, there has been some confusion about what it means. The article pointed out that in combination with existing gold futures priced in yuan, an oil exporter to China contracting to accept yuan could use these two futures contracts to take delivery of physical gold in payment for oil.

I was quoted in that article as follows:

"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,"i

The mechanism of introducing an oil for yuan contract could hardly be clearer, yet the rumour mill went overtime into Chinese whispers. Some analysts appeared to think China was authorising a new oil for gold contract of some sort, or that China would be supplying the gold, both of which are untrue.

The purpose of this article is to put the proposed oil for yuan contract, which has been planned for some time, into its proper context. It requires knowledge of the history of how China’s policy of internationalising the yuan has been developed, and will be brought up to date with an analysis of how the partnership of China and Russia is taking over as the dominant power over the Eurasian land-mass, a story that is now extending to the Middle East.

This fulfils the prophecy of the founder of geopolitics, Sir Halford Mackinder, made over a century ago. He described the conjoined continents of Eurasia and Africa as the World Island, and that he who controls the Heartland, which lies between the Volga and the Yangtze, and the Himalayas and the Artic, controls the World Island.ii The Chinese-Russian partnership is well on its way to controlling the World Island, including sub-Saharan Africa. We know that successive Soviet and Russian leaders have been guided by Mackinder’s concept.

Events of recent months have accelerated the pace of the Heartland’s growing dominance over the World Island, and become pivotal to the balance of global power shifting in favour of the Heartland. Even political commentators in the mainstream media are hardly aware this is happening, let alone future implications. Financial commentators and economists are even less informed, despite the monetary consequences being of overriding importance for the impact on the wealth of nations and their peoples.

This is the backdrop to China’s internationalisation of her currency. To enhance our understanding of the implications of the introduction of yuan futures contracts, we must begin with the relevant monetary developments.

The Hong Kong – London axis

For a considerable time, China has followed a policy of replacing the dollar as its settlement currency for the purposes of trade. After all, China dominates international trade, and on a purchasing power parity basis, her economy rivals that of the US, and if it hasn’t done so already will soon overtake it. From China’s point of view, being forced by her trading partners to accept and pay in dollars is an irritating anachronism, a hangover from American imperialism.

Furthermore, China’s strategic military analysis has convinced her that America uses the dollar as an economic weapon, wielding it to sustain global hegemony and to support her own economy at the expense of others. Therefore, there are clear strategic reasons for China to do away with the dollar for as much of her international and trans-Asian trade as possible.iii

For America’s part, she has strongly resisted moves to have the dollar replaced as the world’s dominant trade currency. America has a tough grip on all commodities, because international physical and derivative markets are priced almost exclusively in dollars. Furthermore, nearly all currency hedging has the dollar on one side of the transaction. This allows the Americans to exercise enormous control over international markets, and even to artificially inflate commodity supplies through the creation of futures contracts, keeping prices lower than they would otherwise be. By these means, America has suppressed the relationship between monetary and price inflation, increasing the apparent stability of the dollar. This is central to the illusion of American monetary hegemony. Therefore, China’s policy of doing away with the dollar is, from the American standpoint, a fundamental challenge to her post-war global domination, and amounts to a declaration of financial war.

China’s problem in displacing the dollar is the lack of an international market for the yuan. Furthermore, with strict exchange controls limiting the ability of Chinese citizens and businesses to trade on the foreign exchanges, it was always going to be an uphill struggle to provide the necessary liquidity in the yuan to make it acceptable to foreign counterparties. China had to come up with a plan, and it made sense to use the existing financial links between Hong Kong and London to develop international markets for her own currency.

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