MotM Brief: The Shanghai International Energy Exchange

The Shanghai International Energy Exchange, INE, began trading oil futures denominated in yuan, today, March 26, 2018.  I wrote about the upcoming significance of this event in China, Gold, and the Dollar.  The initial report was that yuan petro futures would be backed by gold.  This has not occurred, but it does not negate the significance of the impact of INE futures on the dollar.  The yuan petro exchange remains a direct threat to the value of the dollar with continued Federal Reserve dollar mismanagement.

China’s still emerging economy and its reliance on capital controls are not prepared for unilateral gold convertibility.  This would require abandonment of the U.S. dollar link that China has maintained, albeit loosely, since the early 1990s.  The introduction of INE, a trial-and-error process that has taken decades, will advance the ongoing evolution of China into a mature market economy.

It will also directly challenge the value of the dollar.  The U.S. established the petrodollar with the demise of Bretton Wood’s gold-backed dollar stability.  Global oil exchange denominated in dollars kept the dollar dominate as the world’s reserve currency.  It allowed the Fed to mismanage the dollar for perceived domestic purposes and export that error to the global economy.  The world had no choice but to accept dollar error and deal with it.

The INE impacts U.S. dollar dominance.  Every barrel of oil that is exchanged for yuan is an equal amount that is no longer exchanged for U.S. dollars.  This affects the dollar’s status as reserve currency.  Global dollar demand will decrease by a proportional amount.  The Fed will have to adjust base money supply to meet the decline in dollar demand.  The Fed is wholly unprepared to adjust its operating mechanics to decreased dollar demand.  Since Greenspan, who loosely understood gold, the Fed has locked itself into operating policy that ignores all errors indicated by the gold signal.

The outlier to this analysis is the onset of QE, excess reserves, and IOR that began in October 2008, and how it has affected the traditional relationship between dollar supply and demand.  The bottom line is that successful implementation of the INE will correspondingly reduce dollar demand.  Every barrel of oil that is traded in yuan results in an equal amount of dollars that are no longer demanded.  Fed normalization will not account for this decreased dollar demand.  An increase in the price of gold reflects the Fed’s inability to adjust dollar supply to decreased dollar demand.       

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