Petrodollar Exiting Through the Back Door?

“When the dollar collapse comes, it will happen two ways – gradually then suddenly. That formula, famously used by Hemingway to describe how one goes bankrupt, is an apt description of critical state dynamics in complex systems. The gradual part is a snowflake disturbing a small patch of snow, while the sudden part is the avalanche. The snowflake is random yet the avalanche is inevitable. Both ideas are easy to grasp. What is difficult to grasp is the critical state of the system in which the random event occurs.” Jim Rickards, Currency Wars

As already published in the previous Oil and Gold Reports, the US dollar hegemony has been subject to increasing bouts of criticism. China, Russia, and India, but also Japan, are the countries that have gradually been switching the settlement of their bilateral trade in their own currencies or in commodities in order to circumvent the US dollar. This is a clear sign of a paradigm shift, especially since more than two thirds of the US currency is held abroad.

Last year, the Chinese rating agency Dagong Global Credit raised eyebrows when it downgraded the rating of the US to A and reduced the outlook to “negative”. According to Dagong, the QE scheme has sustainably eroded the legitimacy of the US dollar as global reserve currency. The rating agency regards the lack in willingness to pay off the government debt as ignorance vis-à-vis the creditors. In 2011 S&P downgraded the US rating to AA+. Since then, according to S&P, reckless budget policy continues, and a further downgrade is possible. Since Barack Obama took office, the US government debt has increased by 50%.

The Chinese policy of small steps signals the increasing intention to turn the renminbi into a freely convertible currency and to gradually liberalise the capital market. By 2020, China wants to have turned Shanghai into an international financial centre.

The open criticism vis-à-vis US politics is becoming louder even as we speak. And the fact that China wants to achieve full convertibility for the yuan in the long run is becoming clearer by the day. This would be a big step towards a new global leading currency. China is preparing for the post-USD era at full speed. The yuan should outrank the US dollar in terms of global relevance within but a few years. Yi Gang, the co-chairman of PBoC has recently made reference to a liberalisation within the next five years. Li Xiaojing, Managing Director of Bank of China in New York, has already mentioned the preparation work for the day that the Chinese currency will be fully convertible. He regards this as one of the highest priorities. The plans are more than just ambitious, but China has a track record of showing that it is possible to achieve ambitious goals if the political will is there. At the moment only 0.4% of all foreign exchange transactions are settled in Chinese currency. The US dollar has recently accounted for 43% of total transaction, the euro for close to 20%, and the Japanese yen for 10%. This means that the yuan is clearly underrepresented in view of the already central relevance of China for the world’s economy.

Currently, numerous smaller agreements are being signed that reveal the overall long-term strategy. We assume that this is how China wants to gradually boost demand without achieving outright convertibility right away. Within the framework of the new five-year plan, China wants to settle almost 50% of foreign trade in yuan by 2016. It wants to invoice in yuan in the bilateral trade transactions with African or Latin American countries that are rich in resources. Iran for example is said to supply oil for yuan. In addition, the PBoC has allowed almost 70,000 companies to invoice its foreign business worth almost USD 70bn in yuan.

Numerous further examples indicate the fact that the dollar scepticism is growing:

• India wants to pay in gold for Iranian oil. And, according to reports in the media, China may soon follow suit. The two countries together account for almost 40% of Iranian oil exports and are at the same time by far the biggest consumers of gold.
• In October, China reported that it had signed a free trade agreement with the ASEAN  members, in the framework of which transactions would be settled in yuan. China also announced that a central bank for the entire ASEAN region would be set up and the yuan should be the reserve currency. In addition to the ASEAN countries, Japan and South Korea would also be invited to participate in the central bank. Since the bilateral free trade agreement ratified in 2010, trade between China and the ASEAN members has increased substantially. The ASEAN group has meanwhile become the third most important trading partner for China, after US and the EU. By 2015 ASEAN wants to create a common market for its 600mn citizens.
• Ecuador announced it was going to settle its debts owed to China (almost USD 5bn) through future oil deliveries.
• At the beginning of January, Iran and Russia agreed not to trade in US dollar anymore, but instead to resort to rouble and rial.
• India and Japan signed a currency swap agreement worth USD 15bn in order to facilitate bilateral trade.
• In July 2011, China and Iran agreed on a barter set-up for Iranian oil and Chinese goods .
• Japan and China, too, want to circumvent the US dollar even farther . In December Prime Minister Wen Jiabao and the Japanese Prime Minister Noda agreed to promote trade in yuan and yen. China has become Japan’s most important trading partner (USD 340bn per year). Both countries hold the highest volumes of US Treasuries, which is why the symbolic meaning of this agreement cannot be over-emphasized.

By. Ronald Stoeferle of Erste Group

Erste Group is the leading financial provider in the Eastern EU. More than 50,000 employees serve 17.4 million clients in 3,200 branches in 8 countries (Austria, Czech Republic, Slovakia, Romania, Hungary, Croatia, Serbia, Ukraine). As of 31 December 2010 Erste Group has reached EUR 205.9 billion in total assets, a net profit of EUR 1,015.4 million and cost-income-ratio of 48.9%.