China to bring back gold in international settlement with new oil futures
China is planning to bring back
gold standards for
international payment after several decades. Being the world’s largest importer of yellow metal, China is now preparing to launch an
oil futures contract denominated in
yuan and redeemable in
gold. While the
yuan is not yet a global trade settlement currency, China will make the plan possible by backing the
yuan with
gold for settling crude
oil imports. China is also the largest importer of crude
oil.
So far, globally, the dollar has been a major currency to pay for importing crude
oil. China’s plan to import
oil with
yuan backed by
gold would be a game changer as
gold would become the de-facto payment standard despite the fact that all contracts might not finally be converted in
gold.
The
oil contract, to be traded on the Shanghai
International Energy Exchange, will be China’s first futures contract that is open to
international firms for trading. There is no official word on when the contract will be launched but testing has been underway since July.
Nigam Arora, an
international market analyst and author of the Arora Report, said, “China’s move is the beginning of
gold standards for trade in a new form.
Gold is becoming less of a commodity and more of a currency as the contract is backed by nothing other than
gold. If this move takes hold,
gold has the potential to go up by several folds.”
Another implication of the Chinese contract would be that it would create a new
oil benchmark. Currently, Brent and WTI are two different benchmarks accepted globally for crude
oil. Nigam said, “If this initiative is successful, it will create a new benchmark similar to Brent Crude and West Texas Intermediate in
oil. As far as its impact on
gold is concerned, there is not enough freely available
gold in the world to back more than a few small initiatives. Of course, if the price of
gold jumps many folds, the situation will change.”
According to the World
Gold Council’s data, the Chinese central bank holds 1,842.6 tonnes of
gold as part of its reserves, although the yellow metal’s share in China’s total foreign exchange reserves is just two per cent. The US is the largest holder of
gold with 8,133.5 tonnes in reserves. If the
International Monetary Fund’s holding is not considered, China is the fifth-largest
gold holder in forex reserves, according to the WGC. WGC data show that in 2016, China’s
gold demand stood at 915 tonnes, compared to India’s demand of 666 tonnes.
Till date, the US has been surviving on dollar-based settlements for
oil and other trade. For completing any
international deal, even those not involving the US, the buyer first had to buy dollars to pay for imports. The euro has assumed a distant-second place for
international trade sentiment.
Surendra Mehta, the national secretary of the Indian Bullion & Jewellers Association (IBJA), said, “China is looking to upset the current petrodollar system by introducing gold-backed ‘petroyuan’
oil futures contracts. Since China is the largest importer of
oil globally, this massive shift away from the petrodollar could be bad news for the US. However, it could be great news for
gold owners.”
China has always had an interest in getting away from the dollar. In the past, their attempts have not been successful. The present initiative is inspired by US sanctions against Russia and Iran. The US has been successful in enforcing the sanctions because it has a large degree of control over the flow of dollars through the banking system. Getting away from the dollar is the best way to evade US sanctions.
However, drawing attention to some issues that might come up, Mehta said, “Despite rising concerns around the US dollar’s stability and viability, the
yuan is still too illiquid and un-established globally in comparison, causing many exporters to shy away from accepting it.” After convincing Russia, China had also attempted to deal with Saudi Arabia for yuan-based
oil settlement but it didn’t receive a positive response. Hence, Mehta said, “China is taking things one step further with these new gold-backed futures contracts.
Gold solves the petroyuan’s concerns. Russia welcomed the petroyuan with open arms. While on a standalone basis, the
yuan might not be considered acceptable like the dollar,
gold backing hedges that concern.”
Gold prices will spurt if China’s contract succeeds when implemented. Will India’s prices go up too? If China’s contracts succeed, the dollar will weaken and, as a result, the rupee will strengthen.
Gold prices will shoot up sharply but the rise in Indian
gold price will depend upon how much the rupee strengthens, said Mehta.