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“Chinese Game of Gold”

Surendra Mehta, National Secretary- IBJA.

China recently announced they will trade oil for Yuan “backed” by gold. China has had an exchange open for about a year where gold can be purchased with Yuan, though the volumes so far have been very minimal. They have trade arrangements and treaties with Russia, Iran and many other non-western nations. They have also “lobbied” many western nations privately. China has been a huge importer of gold for the last 4-5 years and done so publicly via Shanghai receipts and deliveries. So what exactly does “oil for Yuan” mean? The only things holding the U.S. dollar up from outright death for many years has been the oil trade (and other trade commerce) between nations and settled in dollars. Anyone wanting to buy oil had to first buy dollars in order to pay for the trade. Anyone getting out of step and suggesting they would accept currency other than U.S. dollars was dealt with swiftly and harshly. China is now suggesting they will be the ones to trade oil and not use the dollar for settlement.

Instead, settlement will be in Yuan. But why now? Physical demand for gold has exceeded mine supply by some 1,500 tonnes for the last 20 years “scrap” supply cannot have made up the shortfall. The only places the gold to supply for delivery can have come from are western vaults. If the Chinese know their “supplier” of gold is at or near zero, this could also explain why now China is pushing petrol gold contract. Most importantly it means the world will have an alternative to settling in dollars…. Which means less overall demand for dollars. This alone will weaken the dollar much further than the huge move we have already seen. A weaker dollar will mean much higher prices (inflation) for the imported goods, we no longer manufacture at home. There is a bigger problem here that few are thinking of yet. How will the U.S. settle trade if the dollar becomes so weak it becomes shunned…. And we have no gold for international settlement left? This is very serious question and one pertaining directly to the standards of living for Americans. China is leading a world that is ready to follow in a direction away from dollars. As for gold, it will explode in price in terms of weakening dollar but there is potentially more.

China without any doubt is the largest holder of gold on the planet. It is for this reason China now has the ability to “price” gold wherever they want to. In other words, China can mark the price of gold to moon which will do several things. It will make them the wealthiest nation on the planet while at the same time making it extremely expensive and difficult for anyone to catch up by amassing their own gold horde.

International oil trade is the crux of the issue. For decades, the world’s largest oil importers have paid for oil using the petrodollar, which supports the dollar’s value and fuels U.S. government deficit spending (primarily because the petrodollar is backed by treasuries). But now, China is looking to upset the current petrodollar system by introducing gold-backed “petroyuan” oil futures contracts. And since China is the largest importer of oil globally, this massive shift away from the petrodollar could be bad news for the U.S. but it could be great news for gold owners. Building the petroyuan in June, China took the first step towards overturning the petrodollar by establishing a direct-trade relationship with Russia allowing for oil purchases to be made strictly in Yuan. And just like that, the petroyuan was born. Not long after China’s new deal with Russia, Chinese officials began negotiations for a similar agreement with Saudi Arabia. But the discussion didn’t flow as smoothly as it did with Russia. That’s why China is taking things one step further with these new gold-backed futures contract. Gold solves petroyuan concerns Russia welcomed the petroyyuan with open arms. But other big oil exporters haven’t been as keen to embrace it. Despite rising concerns around the U.S. dollar’s stability and viability, the Yuan is still too illiquid and unestablised globally in comparison, causing many exporters to shy away from accepting it. But China has an ingenious way to solve this problem: simply back the petroyuan with gold. By introducing these new petrouan oil futures contracts that are convertible to gold, China is effectively negating exporters’ fears of accepting the Yuan as trade payment.

Gold holds a significant draw for exporters over the Yuan alone, and these new contracts are opening the door for the petrodollar to be overturned… permanently. The dollar’s value depends massively on its use as an oil trade vehicle. When that goes away, we will likely see a strong and steady decline in the dollar’s value. The U.S. government relies heavily on the geopolitical bargaining power and benefits provided by the petrodollar system. Since the petrodollar is backed by treasuries, the federal government depends heavily on it to fund deficit spending. Without the monetary support of the petrodollar, the U.S. government could soon find itself shouldering an even bigger debt burden than it already is. While the dollar and U.S. government brace for the crushing impact of China’s new game- changing oil trade instrument, there’s one asset that could benefit handsomely from this situation, and that’s physical gold. After many years, physical gold is being reintroduced to the global monetary system in a major way. That alone is incredibly good news for gold owners. Given the choice between trading in something backed by treasuries (which can be created at will from nothing by the U.S. government) or physical gold, what do you think exporters will prefer? Not much of a question, the choice for gold-backed instruments over treasury-backed is kind of a no-brainer…. As more and more nations pile into this new gold-backed oil trade instrument, global demand for physical gold will surge, giving gold prices a tremendous upward thrust.

However, Indians have not much to rejoice as the Indian Rupee price of gold depends on multiplying factor of U.S. dollar and gold price in ounce. If the depreciated value of dollar is offset by appreciation of gold price in ounce, the rupee value of gold may not change. However, this will make Indian gold market more volatile till its actual price is discovered by Chinese market. Hence it also becomes more necessary that India set up its spot exchange not only to discover price and to make trade more transparent, but also to send signals to Chinese government that one of the largest consumer of gold cant’s be ignored in changing the “game of gold.”

Disclaimer: Views are personal and not the views of the publisher.