China's Threat to U.S. Dollar Hegemony

Updated May 2018

As most of us are aware, the United States dollar, for better or worse, is considered the currency of choice, particularly in the world's commodity markets.  Everything from oil to gold to grains is priced in U.S. dollars, a situation which is great for Americans but not so great for those of us who live in nations where the value of our currency, as measured against the mighty U.S. greenback, varies.  The fact that U.S. dollars are the currency of choice for commodities means that consumers in nations outside of the United States are subjected to relatively wild fluctuations in the cost of key items that are totally unrelated to the price of the commodity in U.S. dollars; for example, West Texas Intermediate oil which is currently priced at roughly US$65.00, is priced at $84.00 in Canadian dollars, making it far more expensive for Canadian consumers whose incomes are roughly the same in Canadian dollars as American consumers' incomes are in U.S. dollars. As you will see in this posting, if the Chinese have anything to say about the hegemony of the U.S. dollars when it comes to the price of a key commodity and how it impacts China's economy, it will be a whole different world for the world's commodity markets.

In recent days, there has been a seismic shift in the world's oil markets.  China's yuan-denominated oil futures launched on the Shanghai Futures Exchange/Shanghai International Energy Exchange on March 26, 2018 as shown here:

In total, on the first trading day, 15.4 million barrels of September delivery crude contract were traded.   According to the Reuters news service, among the first to buy the September contracts were Glencore, Freeport Commodities and Trafigura.  This could be the dawn of a new oil price benchmark that could, if handled well by Chinese authorities, provide a rival to the current dominant position occupied by West Texas Intermediate and Brent crudes. This should not be surprising given that China is now the world's largest oil importer; as a result, the nation is becoming increasingly influential in the world's oil markets.  To avoid the possibility of speculation on the new oil contracts, Beijing has increased the cost of oil storage which will be set at about U.S.$0.95 per barrel per month compared to U.S.$0.02 plus per barrel per month for storage at Louisiana's Offshore Oil Port (LOOP) as shown here:

As well, the daily trading band has been set at plus or minus five percent with margin requirements being 7 percent.  The contract size has been set a 1000 barrels per lot with a threshold investment of RMB 500,000 for individuals and 1 million yuan for institutional investors 

Here is the reasoning behind the Chinese crude oil futures market:

"The aim of building up a Chinese crude oil futures market is to provide enterprises with   effective price risks management tools and also risk preventions for their on-going operations.  Moreover, despite of the well-developed crude oil futures markets in Europe and US, theirs prices cannot fully give an objective reflection of supply-demand relationship in Asia Pacific. To launch Chinese own crude oil futures will help formulate a benchmark price system that reflects the supply-demand relationship of crude oil in China and Asia Pacific Region. Also, we can optimize the resources allocation in the market-driven approach so as to better serve the real economy. To build up a crude oil futures market is one of the most important practices that we carry out to promote opening-up and internationalization in Chinese futures market.

Our general thinking is “international platform, net trading, bonded delivery and RMB denomination”. International platform means the internationalization of trading, delivery and clearing, which gives domestic and foreign investors a free, efficient and easy access to the local market. With the support of spot crude oil market, INE will introduce domestic and international investors including multinational oil companies, oil traders and investment banks to trade in this market. So that they can better build up a benchmark price that reflects the supply-demand relationship in China and the Asia Pacific Region."

In addition to the use of China's currency for oil trading, some of China's trade partners are also considering the use of China's yuan for trade with China rather than the U.S. dollar.  According to Pakistan's Federal Minister for the Interior, Ahsan Iqbal, Pakistan is examining the use of the yuan for trade between the two nations as part of its China-Pakistan Economic Corridor.  As well, Russia's Gazprom Neft, one of the nation's largest oil producers and refiners, shipped roughly 20,000 BOPD to China in 2015, settling the transaction in yuan.  This was done, in part, as a response to U.S. economic sanctions imposed on Russia after the events in Ukraine.  By diversifying away from the U.S. dollar, the United States loses some of its clout when trying to punish what it deems as "bad behaviour" by Russia.

While these developments are interesting, as we can see on this table from the International Monetary Fund, even the IMF has now adopted the renminbi as a one of its currencies of choice when it comes to its Official Foreign Exchange Reserves as shown here:

...and here:

With the global financial system being dominated by the U.S. dollar, euro and yen, until now, China's currency has received little attention, rather surprising given its status as the world's second largest economy as shown here:

...and here:

Although the American economy leads China's by $7 trillion, in 2016, China's economy grew by 6.7 percent compared to only 1.6 percent for the U.S. economy according to the IMF.  In fact, a study by PriceWaterhouseCoopers shows that the economies of both China and India will dominate the global economy by 2050, pushing the United States economy into third place as shown here:

By 2050, China's economy will comprise 20 percent of the global economic output, dwarfing the U.S. economy which will fall to only 12 percent of the global economy.

While the current China-based, yuan-based oil market is hardly a threat to the current dominance of the U.S. dollar-based oil market, it is the first significant move to work around use of the U.S. dollar, a move that will impact Washington's abilities to use sanctions to force China and its trading partners to behave in a manner which is deemed acceptable to whatever administration happens to occupy the White House.  It will be interesting to watch the geopolitical implications as the world continues to shed the U.S. dollar as the global currency of (forced) choice and what steps Washington will take to ensure that it continues to get its own way globally.