Could China oil Exchange & Green Energy pull the plug on the Dollar?

By Juan Cole | (Informed Comment) | – –

Kate Duguid at Reuters reports the alarm at UBS that China’s new oil futures exchange will hurt the standing of the dollar as the world’s reserve currency.

That development in turn would start the reverse snowball down the hill, with the dollar falling against other currencies, causing high inflation for US consumers of imported goods, and the Congressional addiction to big budget deficits (Trump just added a $1.5 trillion deficit to give tax breaks to his billionaire cronies) coming home to roost.

Petroleum futures have long been denominated in dollars, and you need to buy dollars to purchase them. (This issue is complex. Traders tell me that when the dollar has been weak against the Euro, oil has often de facto been denominated in Euros anyway. But I suppose the need to purchase dollars for the sale has remained).

The oil sellers, such as Saudi Arabia, also keep their profits in US Treasury Bonds, which helps offset US budget deficits. This practice is a remnant of the oil price spike of the 1970s, when a quadrupling of the price of petroleum threatened Western economies at the height of the Cold War, and Nixon and Kissinger worked out ways of recycling money from the oil producers to the West (arms sales was another, leading to wars like the current one in Yemen).

So if you don’t need to buy dollars to purchase petroleum at the Shanghai exchange and you don’t need to keep your profits in US Treasury Bonds, then the world demand for dollars falls dramatically, Hayden Briscoe of UBS argues.

The basic premises of US deficit financing would collapse.

Duguid and Briscoe started me thinking along other lines, too. Briscoe, I think, vastly underestimates the impact of electric vehicles on Chinese oil demand in the next two decades.

But then, wouldn’t the rise of the EV add dramatically to the effect of the petro-yuan?

That is, not only will demand for dollars to fund futures oil purchases fall because some of those buys are made in yuan, but demand will also fall as people fuel their vehicles from sunlight and wind. And not only will buying of US treasuries fall off because oil sellers are operating in yuan, but Treasury Bonds will be in less demand as petroleum as a commodity dwindles into insignificance.

Two further thoughts on all this, one foreign and one domestic.

The Obama administration put Iran under severe economic sanctions so as to force it into the 2015 nuclear deal, using the supremacy of the dollar to strong-arm other countries into not buying Iranian oil. Under China’s new exchange, this tool of US dominance will be substantially blunted. Countries that wanted to buck the US on Iran oil purchases could just go to Shanghai. I said at the time that using the position of the dollar as the world reserve currency in what was basically economic warfare on Iran would certainly cause China, Russia and other powers to attempt to sidestep the dollar. That now appears to be happening.

Second, the Reagan-to-Trump tax scam, whereby taxes are slashed on the rich and vast inequalities are promoted in American society, aiming at the creation of a new aristocracy, has depended on the dollar’s position as a reserve currency. Ordinarily, cutting taxes on the people with the money to pay them and then running consistent big deficits would cause inflation and would vastly weaken a currency against other currencies. But the Washington elite has skated by essentially offloading the costs onto international holders of dollars.

If many fewer world actors hold dollars, not needing them for petroleum sales, then the US economy could take an enormous hit as the budget deficit chickens come home to roost. Congress will then have a choice of raising taxes on its bosses among the rich or knee-capping the public by abolishing social security, medicare, road building and service provision. That is, the peculiar insouciance of American workers to being systematically screwed over may have in part derived from the cushion of the dollar as a world reserve currency, and once the cushion is gone the US may start looking more like France.

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Bonus video:

New China TV: “Roaring into action! China launches yuan-denominated crude oil futures”

19 Responses

  1. Thank you very much, Juan, for elucidating this so clearly to the general public.

    For those of us who tried to look at these things, such scenarios have been looming for decades. The generations-long dominance of America in world politics and economics has been very much to our economic advantage, but it is highly unusual in world affairs and is by no means guaranteed to continue – especially if we are barely noticing how the top 1% of the 1% keep sucking up nearly all growth in income and getting their way in most political matters, and then we elect a certified idiot con-man who may have been greatly boosted by the world’s worst, most corrupt dictatorship to be our President.

    The fall may well be fatal to everything that we individually and collectively hold dear.

  2. I think we should give a nod to Bush the lesser in the tax scam sentence as “,Reagan-to-Bush-to-Trump tax scam,”.

  3. Very clearly written thank you for someone with a Euro pension planning to move to a current Dollar based country, I am rubbing my hands in glee!

  4. Though called the US dollar, for decades it has been a universal currency. Even poverty is identified in dollars with sweat shop earnings defined as so many dollars an hour or day. In a certain sense the US dollar has been a globally cohesive factor. Once it started to be used coercively, however, it began to impede trade which is fatal. Trade always finds a way round obstacles; it is an absolute, as old as the first neighbour. It’s strange that Trump, a serial bankrupt, should have turned up as POTUS at precisely this moment; enough to reawaken belief in the mischievous hand of Fate, or at any rate the inexorable consequences of hubris.

  5. “look like France?” You mean we’ll have single-payer health care, decent vacations, be thin, have a rational-sized but effective military, and decent cheese? Sign me up!

  6. “Johnnie, you don’t want to wind up pick’n shit with the chickens”, was my mothers admonishment in 1951 when
    I was a lad of eighteen. Now, at eighty five, I have a feeling
    that it may come to pass before I am listed as Deceased.

  7. I think the US may start a world war if any nation tries to change the world currency status of American dollar that has created an artificial strong currency status

  8. China has very quietly but openly been building an alternative to the USA controlled (but UK owned) SWIFT financial transaction network that does NOT use US dollars. China has been setting up alternatives to the USA controlled international development funds. Often offering much better terms that the USA.

    Basically, China has looked at the financial structures that allowed the USA to manipulate international finance and duplicated them (and often vastly improved them).

    Now China has most of the structures in place to provide alternatives to all the USA financial structures, all based on a basket of currencies (but NOT the USA dollar). That is, the world can now afford to throw the USA overboard and continue to function very well.

    Oops . . .

  9. I am not an economist but follow MMT, Stephanie Kelton and Warren Mosler among others and I don’t think you are correct with regard to US deficit spending. Warren Mosler
    “Taxes function to regulate aggregate demand, and not to raise revenue per se.
    link to tinyurl.com

    Mosler also believes that imports are income and exports expense in which case increased costs for Americans may lead to Recession or worse rather then inflation.

  10. Heck of a time to start a trade war. Good likelyhood of another oil supply/demand bottleneck in five years and US oil patch won’t have the same circumstances to respond. Just as likely Fed fuel tax will not have been raised to fund infrastructure.

    • While there could be decreases in global oil production within five years, the shift to non-carbon energy, even in transportation will be much farther along than now. Other than the USA, most of Europe and Asia are rapidly decreasing their usage of carbon energy because it just makes so much sense from an economic standpoint.

      Note that China is well ahead of their non-carbon energy targets. I think India is also moving fairly fast. As China and India shift off carbon energy, there will be a big hole in the market demand, so even if there is a decreased supply, the demand may closely match and the price may be some what stable.

      Most countries (other than the USA) are well aware that non-carbon energy is now CHEAPER than carbon energy, so they are investing as much as they can to convert as quickly as possible.

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