Global reserves preference in fiat U.S. dollars or gold
The Nikkei Asian Review reported a global financial bombshell on September 1, 2017.
“China is expected shortly to launch a crude oil futures contract priced in yuan and convertible into gold in what analysts say could be a game-changer for the industry.
The contract could become the most important Asia-based crude oil benchmark, given that China is the world’s biggest oil importer. Crude oil is usually priced in relation to Brent or West Texas Intermediate futures, both denominated in U.S. dollars.
China’s move will allow exporters such as Russia and Iran to circumvent U.S. sanctions by trading in yuan. To further entice trade, China says the yuan will be fully convertible into gold on exchanges in Shanghai and Hong Kong.”
The end of the petro dollar?
This is the inevitable culmination of 46 years of Federal Reserve dollar mismanagement through devaluation. Nixon’s termination of the Bretton Woods international monetary system ended the United State’s successful, 179 year experiment with constitutionally mandated gold-backed currency. The monetary history of economics is a continuous cycle of gold-backed currency, followed by devaluation, economic collapse, and an eventual return to gold. No country has ever achieved prosperity through currency devaluation, only economic ruin. Nathan Lewis chronicles this pattern in great detail, from the beginning of recorded history, in his new book, Gold: The Final Standard.
Since January 1994 the PBOC has essentially linked the yuan to the dollar. From 1995 to 2005 the PBOC maintained the yuan at the fixed rate of 8.3 to the dollar. The PBOC has loosened the fixed rate over the intervening decade, but the yuan still trades in a narrow band with the dollar. The loosening of the fixed rate is due to relief from Federal Reserve dollar mismanagement. With the yuan linked to the dollar, the PBOC imports the Fed’s monetary errors. As an emerging economy without a history of mature debt and credit facilities, dollar monetary distortions have a greater effect upon China’s economy. It’s like being in the last car on a rollercoaster. Emerging markets get whipsawed by Fed dollar error. When the Fed sneezes, emerging markets catch the flu—as the 1997 Asian crisis demonstrated.
Over the last 20 years, the yuan has traded in a variable range relative to the dollar of 3 yuan while during the same period, the dollar has traded in a $1600 range with gold. It should be obvious from observing the yuan-dollar link in comparison with the dollar-gold link that China’s monetary management is not the problem. It is the Fed that has grossly mismanaged the value of the dollar since 1971. Yet, the U.S. bases its foreign policy toward China on the false accusation of Chinese currency manipulation. From this we accuse China of unfair trade. Global currency stability must come first before other trade issues can get sorted out. It is no wonder that China desires independence from Kafkaesque U.S. trade and foreign policy based upon fiat dollar hegemony.
Dollar Yuan Exchange Rate
As China’s crude oil futures contract priced in yuan and convertible into gold develop, it will immediately exert pressure on the yuan-dollar exchange rate. The yuan cannot maintain a fixed exchange rate with a depreciating dollar while providing convertibility to gold. This will result in an outflow of China’s gold reserves. This is exactly what happened with the dollar under Bretton Woods when U.S. domestic economic policy attempted to manipulate the dollar’s value while maintaining the gold convertibility window. Foreign central banks exchanged their depreciating dollar reserves for gold. The result was an outflow of U.S. gold reserves. Instead of mopping up excess dollar liquidity that caused the problem, the U.S. requested of the British government that the London gold markets be closed. The U.S. offered treasuries denominated in depreciating dollars instead of gold. When this was no longer sustainable with continued dollar depreciation, Bretton Woods collapsed. Nixon formally closed the gold window to foreign central banks in August 1971.
Nathan Lewis outlines the three currency options in Gold: The Final Standard.
Currency Option One: A fixed-value policy, free trade and no capital controls, and an automatic currency-board-like system with no discretionary domestic monetary policy.
Currency Option Two: A floating fiat currency, free trade and no capital controls, and a discretionary domestic monetary policy.
Currency Option Three: A fixed-value policy, trade and capital controls, and a discretionary domestic monetary policy. This is sometimes called a “pegged” currency.
The “Classical gold standard” period from 1870 to 1914 was the epitome of Currency Option One. All major countries linked their currencies with gold. There was essentially a unified global currency based upon the monetary stability of gold. Trade flowed freely. This was an era of rapid advancement in industrialization, growth, and standards of living and is still the blueprint in form for return to global growth based upon monetary stability.
China will have to move from Currency Option Three to Option One. The yuan will never be a global currency without the free flow of capital. China’s capital controls are incompatible with gold convertibility and the yuan as a global currency.
Of course there is no reason that the United States need sit helplessly back and watch China attempt to usurp the dollar as the world’s reserve currency. The U.S. with its history of mature markets, rule of law, property rights, individual freedom, and free flow of capital can easily return the dollar to a gold standard and include China. Constitutional principles, though continuously eroded, still govern the independent spirit of Americans. It is time to end the dollar as a devaluation weapon of foreign policy hegemony and return it to its role as an unwavering unit of account. With a return to a dollar gold standard, will come the illusive prosperity that flummox economists and politicians.