In this article we will look at what the petrodollar is, the dollar’s status as world reserve currency, the rise and rise of China and how gold could yet again be taking centre stage.
A background of the Petrodollar
By 1971, US debt was deemed to be out of control (ironically, nowhere near today’s levels) Just $11 billion in gold backed $24 billion in dollars. Such was the worry, that in the summer of 1971, the French President sent a warship to New York to collect its nation’s gold from the Federal Reserve. Also that summer, the British – seemingly astute to the impending doom, asked the US to prepare $3 billion worth of gold held in Fort Knox for withdrawal. Later that month President Richard Nixon told the American people that the US would no longer redeem dollars for gold, and the gold standard was no more. The dollar would later become more and more used across the globe and became stronger against its peers.
In 1974, the US was gravely concerned about the debt problem. In a diplomatic strategic play, they sent new Treasury Secretary William Simon on a fortnight’s diplomatic tour indirectly to Saudi Arabia to find a way to persuade them to finance America’s widening deficit with its newfound petrodollar wealth. Quite a task, however the US had a trump card to play: their gambit was, to buy oil from Saudi Arabia and provide the kingdom with military aid and equipment. I.e. they would form a coalition and promise to protect and arm their country. In return, the Saudis would spend billions of their petrodollar revenue back into treasuries and financially back America’s spending. Given the might of the US military, the plan was met with popular approval from the Saudis. Such was this certainty of dollar hegemony it also paved the way for commodities to be priced in dollars further down the line.
Still to this day, the world relies on the US dollar and US treasuries. They give America comparative control across the globe as countries must buy dollars to buy commodities priced in the US currency. Nearly 90% of international currency transactions are in US dollars and 60% of foreign exchange reserves are held in dollars. Quite amazingly, almost 40% of the world’s debt (some $120 Trillion) is in US dollars – a point that hasn’t gone unnoticed on how that problem could be wiped away. Such was the dominance of the US, it was leaving other countries a long way behind. This however was to change and dramatically so.
The rise of China
China over the last few decades has grown and grown and is now a triumph of global power. Since opening up to foreign trade and investment and implementing free-market reforms in 1979, China has been among the world’s fastest-growing economies, with GDP growth experiencing the quickest sustained expansion by a major economy in history. Such growth has enabled China, on average to double its GDP every eight years. A threat to the US world dominance was fast emerging from the East.
Money Week reports that since 2000, China has mined 6,500 tonnes of Gold and that an additional 6,000 tonnes has entered China mostly via Hong Kong. Their estimation of China’s Gold holdings today sits at just shy of 30,000 tonnes. Some analysts think that is a conservative figure. This would put China head and shoulders above the US and the rest of the world in Gold assets. They clearly see Gold as structurally important in the future.
In 2013 China launched their “Belt and Road” initiative, investing billions of dollars in 70 other countries. The blueprint was simple; to extend infrastructure enabling international trade through markets, accelerating economic growth across Asia, Africa and Europe. Planting seeds in other countries however has only gone further in gaining China significant international diplomatic accolades. Quite the contrary to the US and their recalcitrant mannerisms towards foreign policy.
A further warning shot was fired across the US bow in 2018 when China launched yuan-denominated oil futures contracts in Shanghai known as (wait for it) the petroyuan. Putting to one side how long it must have taken China to come up with that name, more prominent was the intention for internationalising its currency and competing with the US. China was beginning to flex her muscles, promote her currency and rely less and less on US dollars. Don’t forget the Yuan was the most recent currency to join the basket of the IMF’s Special Drawing Rights. It isn’t just seen by China as important.
In May 2020, in a broader show of both ingenuity and dominance China began the trial in four major cities of its digital yuan, which culminated from six years’ of development. Although no timetable has been set for its permanent rollout, like all CBDCs it is coming. China, as a sign of global independence and development have led the way. This is a huge political statement and one that starts to ask serious questions of dollar hegemony.
Geopolitics and Gold
On Aug. 24 2021 the Saudi Deputy Defence Minister announced on Twitter that he had signed an agreement with Russian Deputy Defence Minister aimed at “developing joint military cooperation between the two countries.” Six days’ later the US completed their withdrawal from Afghanistan under intense pressure from The Taliban. Coincidence? Highly doubtful, especially as it is widely reported that China has been meeting with the Taliban dating back to July this year.
So what does all this mean for the Dollar, Oil and Gold? Well, quite a lot actually.
I have previously written articles on the global power shift from West to East, and how China and Russia have become less and less reliant upon the dollar. Whilst we have covered the gold reserves of China above, Russia’s is also rumoured to be well in excess of what the US claims to have. When the US came off the Gold standard exactly 50 years’ ago, the relevance of debt, the position of the dollar and the importance of Gold are a half century’s paradigm of repetition, albeit with a slightly less correlated dynamic. For years the US has had the financial clout and military strength to back its world reserve status. The cold war style threat from the East is far more than embryonic posturing.
The withdrawal from Afghanistan leaves almost no physical ties left for the US in The Middle East. Trump wanted his nation to be self sufficient when it came to energy and stood proud of the resources that the US had in natural gas and oil and how he wanted the world to trade with American produce, yet still keep ties strong with Saudi Arabia. Biden’s approach has been very different, and severing relations with the Middle East could have much larger ramifications.
Without weighing down on politics here, it seems China’s intentions are clear: they want their currency to compete with the dollar as world reserve and eventually take its place. They have the economy, the industry, the military and the growing reputation. They have left several clear footprints over the last few years which couldn’t be more brazen, and I suspect there is very good reason for this smoking gun. China appears to be several steps up the ladder with the top rung in plain sight. The US on the other hand has many reasons to be less sanguine as the cracks in the wall of their domination begin to widen.
Summary
The US has global and military might and has done for years. It’s economy sits at the top of the tree, and it still has domination. Absent some catastrophic event, this won’t change overnight. The mechanics of such change take years, however China appears well underway to challenge the status of the US.
The petrodollar isn’t the be all and end all of the dollar’s legacy as world reserve currency, but much like the size of the EUR/USD against the dollar index, it’s existence is highly weighted against it, in political terms as much as financial. If the petrodollar was to be replaced, and there is evidence to suggest it could in the not too distant future, it could be the straw that breaks the Camel’s back ending the dollar as the world’s reserve currency. The corollaries of this leave little to the imagination; it would be brutal for the US.
The question of what replaces it, could be sitting in China in the form of a digital yuan backed by a world leading accumulation of gold.