On March 26 China will finally launch a yuan-dominated oil futures contract. Over the last decade there have been a number of “false-starts,” but this time the contract has gotten approval from China’s State Council.
With that approval, the “petroyuan” will become real and China will set out to challenge the “petrodollar” for dominance. Adam Levinson, managing partner and chief investment officer at hedge fund manager Graticule Asset Management Asia (GAMA), already warned last year that China launching a yuan-denominated oil futures contract will shock those investors who have not been paying attention.
But this isn’t just some slow, news day “fad” that will fizzle in a few days.
Back in 2015, the first of a number of strikes against the petrodollar was dealt by China. Gazprom Neft, the third-largest oil producer in Russia, decided to move away from the dollar and towards the yuan and other Asian currencies.
Iran followed suit the same year, using the yuan with a host of other foreign currencies in trade, including Iranian oil.
During the same year China also developed its Silk Road, while the yuan was beginning to establish more dominance in the European markets.
Now that China is the world’s leading consumer of oil, Beijing can exert some real leverage over Saudi Arabia to pay for crude in yuan. It’s suspected that this is what’s motivating Chinese officials to make a full-fledged effort to renegotiate their trade deal.
So fast-forward to now, and the final blow to the petrodollar could happen starting on March 26. We hinted at this possibility back in September 2017…
With major oil exporters finally having a viable way to circumvent the petrodollar system, the U.S. economy could soon encounter severely troubled waters.
First of all, 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.
Once the oil markets are upended, the yuan has an opportunity to become the dominant world currency overall. This will further weaken the dollar.
The White House is preparing to unveil $50 billion worth of tariffs on more than 100 different types of Chinese goods Thursday at 12:30 pm ET - what President Trump has characterized as a response to China's larcenous Intellectual Property practices (and, quite possibly, a preemptive strike as China prepares to launch its petroyuan contracts next week).
This is how UBS' Chief US Economic Paul Donovan summarized what is coming:
US President Trump is expected to announce a tax increase for US consumers who have dared to purchase goods that have been partially made in China. There is likely to be a large US flag, suitably photogenic and smiling American workers and a dramatic signature. And selective tariffs, investment restrictions and visa limits.
US Trade Representative Lighthizer said that an "algorithm" was used to maximize the pain to China and minimize the pain to US consumers (this acknowledges that there is pain for US consumers). Trade data (presumably the algorithm input) is complex and often out of date. Saying the word "algorithm" in an authoritative voice does not magically reduce the risks.