The purpose of this article is to put the proposed oil for yuan contract, which has been planned for some time, into its proper context. It requires knowledge of the history of how China’s policy of internationalising the yuan has been developed, and will be brought up to date with an analysis of how the partnership of China and Russia is taking over as the dominant power over the Eurasian land-mass, a story that is now extending to the Middle East.
This fulfils the prophecy of the founder of geopolitics, Sir Halford Mackinder, made over a century ago. He described the conjoined continents of Eurasia and Africa as the World Island, and that he who controls the Heartland, which lies between the Volga and the Yangtze, and the Himalayas and the Artic, controls the World Island.ii The Chinese-Russian partnership is well on its way to controlling the World Island, including sub-Saharan Africa. We know that successive Soviet and Russian leaders have been guided by Mackinder’s concept.
Events of recent months have accelerated the pace of the Heartland’s growing dominance over the World Island, and become pivotal to the balance of global power shifting in favour of the Heartland. Even political commentators in the mainstream media are hardly aware this is happening, let alone future implications. Financial commentators and economists are even less informed, despite the monetary consequences being of overriding importance for the impact on the wealth of nations and their peoples.
This is the backdrop to China’s internationalisation of her currency. To enhance our understanding of the implications of the introduction of yuan futures contracts, we must begin with the relevant monetary developments.
The Hong Kong – London axis
For a considerable time, China has followed a policy of replacing the dollar as its settlement currency for the purposes of trade. After all, China dominates international trade, and on a purchasing power parity basis, her economy rivals that of the US, and if it hasn’t done so already will soon overtake it. From China’s point of view, being forced by her trading partners to accept and pay in dollars is an irritating anachronism, a hangover from American imperialism.
Furthermore, China’s strategic military analysis has convinced her that America uses the dollar as an economic weapon, wielding it to sustain global hegemony and to support her own economy at the expense of others. Therefore, there are clear strategic reasons for China to do away with the dollar for as much of her international and trans-Asian trade as possible.iii
For America’s part, she has strongly resisted moves to have the dollar replaced as the world’s dominant trade currency. America has a tough grip on all commodities, because international physical and derivative markets are priced almost exclusively in dollars. Furthermore, nearly all currency hedging has the dollar on one side of the transaction. This allows the Americans to exercise enormous control over international markets, and even to artificially inflate commodity supplies through the creation of futures contracts, keeping prices lower than they would otherwise be. By these means, America has suppressed the relationship between monetary and price inflation, increasing the apparent stability of the dollar. This is central to the illusion of American monetary hegemony. Therefore, China’s policy of doing away with the dollar is, from the American standpoint, a fundamental challenge to her post-war global domination, and amounts to a declaration of financial war.
China’s problem in displacing the dollar is the lack of an international market for the yuan. Furthermore, with strict exchange controls limiting the ability of Chinese citizens and businesses to trade on the foreign exchanges, it was always going to be an uphill struggle to provide the necessary liquidity in the yuan to make it acceptable to foreign counterparties. China had to come up with a plan, and it made sense to use the existing financial links between Hong Kong and London to develop international markets for her own currency.
We can date public awareness of China’s strategy to June 2012, when Hong Kong Exchanges and Clearing made a successful offer for the London Metal Exchange. While noting that Hong Kong is an autonomous region, and that, officially at least, China does not meddle in Hong Kong’s affairs, China has a direct interest in important acquisitions of this sort. China is the world’s largest importer of base metals, and London is the global metal pricing centre for warehouse stocks and physical delivery.
The LME earlier this year decided to offer a series of precious metal futures contracts, priced in dollars, centred on gold. The gold contract has been a great success, something guaranteed when you bear in mind that the Industrial and Commercial Bank of China, owned by the Chinese state, is a lead sponsor of these precious metals contracts. By this action, China is parking its tanks on the London Bullion Market Association’s lawn. At some stage in the future, the LME will almost certainly offer deliverable futures contracts priced in yuan, not just for precious metals but for base metals as well.
In October 2013, fifteen months after the acquisition of the LME, Boris Johnson as Mayor of London led a trade mission to Beijing. British trade missions are a major feature of Foreign Office duties, the way Britain develops bilateral trade relationships. These trade missions, being planned through diplomatic channels, are prearranged and coordinated well in advance. Therefore, it was unusual to find that George Osborne, the Chancellor of the Exchequer, at very short notice got up a second trade mission, and met Johnson in China.
The reasons for this turn of events were never properly explained; however, we can work them out. In May 2012, David Cameron had met the Dalai Lama in London, which caused a diplomatic furore with China. Despite this earlier public spat and the point having been made, Osbourne was sent to China. While it is likely his trade mission was a cover for UK Government efforts to smooth things over, subsequent events suggest financial cooperation between Hong Kong and London was discussed, and Chinese plans to use Hong Kong and London to enhance the yuan’s international liquidity were agreed in principal. Following Osborne’s visit, David Cameron himself went to Beijing for discussions with President Xi the following month, confirming the importance to Britain of bilateral financial relations with China.
The following year, the UK took the unusual step of issuing a 3bn yuan bond, both as an indication of intent, and to help kick-start the offshore yuan market in London. This was followed by Britain being the first non-Asian nation to join the Asia Infrastructure Investment Bank as a founder member in March 2015 (announced by none other than George Osborne). The AIIB, which was set up by China and headquartered in Beijing, is the first supra-national organisation independent of the Bretton Woods institutions, which are all controlled by the US. These institutions, led by the World Bank and the IMF, as well as several regional development banks, were how the US, using the dollar, dominates the world’s finances. The establishment of the AIIB was an unwelcome development for America, and the US expressed acute disappointment that Britain had decided to join.
And lastly, after six or seven years of lobbying the IMF, the yuan was finally included in the SDR basket from 1 October last year, further promoting it as a trade settlement currency to be included in foreign countries’ reserves.
There can be no clearer evidence of China’s intention to replace the dollar with her own currency, than the sequence of events outlined above. She identified that Britain’s interests were aligned with her own, enabling her to cut out America from future developments. She has obtained arms-length control over London’s physical metal exchange. She had set up a non-dollar rival to the World Bank and IMF, ensuring future Asian development financing is under her control. And, with more than 80 member countries eventually joining the AIIB, she has successfully picked off America’s allies. The inclusion of the yuan in the SDR basket can be taken as an acknowledgement of China’s importance on the world stage.
The eventual intention is to price in yuan everything imported into and exported from China. Much trans-Asian business is already settled in yuan, and even remote Angola settles her oil sales to China in yuan. It will in time involve developing yuan futures contracts for all the tradeable commodities the state deems significant. The most important of these is a standard oil contract. But before we cover the genesis of the oil contract, we should remind ourselves about China’s gold strategy.
Cornering the physical gold market
It is only relatively recently that Western capital markets have become aware that Chinese demand for physical gold absorbs large quantities of annual mine production, and that the country is now the largest mining nation by far, extracting it at a rate of over 450 tonnes per annum. Knowledge of China’s overall demand is restricted to deliveries out of the Shanghai Gold Exchange’s vault into public hands, running at about 2,000 tonnes per annum, which with India’s public demand accounts for nearly all global mine extraction of about 3,000 tonnes.
The SGE was established in 2002, yet China began to embrace capitalism in 1980, when the first Special Economic Zone was established. China at that time showed reserves of 395 tonnes, a figure that was unchanged until 2001, when it was increased to 500 tonnes, and the following year to 600 tonnes, which it remained until 2009. Over this time, the Chinese economy enjoyed enormous capital inflows from 1980 until the early 1990s, when Western companies set up manufacturing facilities. These were followed by growing export surpluses thereafter. The Peoples Bank of China (PBOC), the state-owned central bank, was managing the currency, neutralising these flows by buying mostly dollars.
It also made sense for the Chinese to diversify the foreign exchange portfolio gained through intervention. The need to increase gold holdings would have been obvious to communist-trained economists at the heart of government. They had had the Marxist belief drummed into them that capitalism would eventually destroy itself, and the capitalists’ paper currencies with it. Rather like Germany in the 1950s and the Arabs in the 1970s, they felt it was prudent to put a significant part of their foreign exchange into gold.
Consequently, new regulations appointing the PBOC to “guarantee the state’s requirements for gold and silver” came into force on June 15, 1983.iv Private ownership of gold and silver remained banned.
It should be noted that state-owned gold declared as official reserves bear little relation to the total accumulated. Anecdotal evidence informs us that bullion is dispersed into accounts in the possession of the Peoples Liberation Army and the Communist Party. Therefore, we cannot know China’s true holdings. All one can do is make a reasonable assessment of how much gold the PBOC is likely to have accumulated since 1983 and before 2002, when private citizens were allowed for the first time to buy physical gold and silver. During this period gold had suffered the greatest bear market in the history of fiat currencies. The scale of redistribution from weak hands into stronger long-term hands was enormous, bearing in mind that Indians, the other great national buyers today, only began to buy gold in significant quantities in the early-nineties, after the repeal of the 1968 Gold Control Act in 1990. It is also known that in 1990-2000, many Middle Eastern portfolios sold gold in favour of equity investment, as did many other private investors with Swiss private bank accounts. Furthermore, central banks were leasing gold in large quantities, artificially inflating physical supply.
Taking all these factors into account, plus mine production totalling 42,460 tonnes over the period, it was easily possible for the Chinese state to secretly amass over 20,000 tonnes by 2002, through a process of gradual accumulation. As to whether they did so, we must look at the evidence from China’s gold strategy.
It is only relatively recently that Western capital markets have become aware that Chinese demand for physical gold absorbs large quantities of annual mine production, and that the country is now the largest mining nation by far, extracting it at a rate of over 450 tonnes per annum. Knowledge of China’s overall demand is restricted to deliveries out of the Shanghai Gold Exchange’s vault into public hands, running at about 2,000 tonnes per annum, which with India’s public demand accounts for nearly all global mine extraction of about 3,000 tonnes.
The SGE was established in 2002, yet China began to embrace capitalism in 1980, when the first Special Economic Zone was established. China at that time showed reserves of 395 tonnes, a figure that was unchanged until 2001, when it was increased to 500 tonnes, and the following year to 600 tonnes, which it remained until 2009. Over this time, the Chinese economy enjoyed enormous capital inflows from 1980 until the early 1990s, when Western companies set up manufacturing facilities. These were followed by growing export surpluses thereafter. The Peoples Bank of China (PBOC), the state-owned central bank, was managing the currency, neutralising these flows by buying mostly dollars.
It also made sense for the Chinese to diversify the foreign exchange portfolio gained through intervention. The need to increase gold holdings would have been obvious to communist-trained economists at the heart of government. They had had the Marxist belief drummed into them that capitalism would eventually destroy itself, and the capitalists’ paper currencies with it. Rather like Germany in the 1950s and the Arabs in the 1970s, they felt it was prudent to put a significant part of their foreign exchange into gold.
Consequently, new regulations appointing the PBOC to “guarantee the state’s requirements for gold and silver” came into force on June 15, 1983.iv Private ownership of gold and silver remained banned.
It should be noted that state-owned gold declared as official reserves bear little relation to the total accumulated. Anecdotal evidence informs us that bullion is dispersed into accounts in the possession of the Peoples Liberation Army and the Communist Party. Therefore, we cannot know China’s true holdings. All one can do is make a reasonable assessment of how much gold the PBOC is likely to have accumulated since 1983 and before 2002, when private citizens were allowed for the first time to buy physical gold and silver. During this period gold had suffered the greatest bear market in the history of fiat currencies. The scale of redistribution from weak hands into stronger long-term hands was enormous, bearing in mind that Indians, the other great national buyers today, only began to buy gold in significant quantities in the early-nineties, after the repeal of the 1968 Gold Control Act in 1990. It is also known that in 1990-2000, many Middle Eastern portfolios sold gold in favour of equity investment, as did many other private investors with Swiss private bank accounts. Furthermore, central banks were leasing gold in large quantities, artificially inflating physical supply.
Taking all these factors into account, plus mine production totalling 42,460 tonnes over the period, it was easily possible for the Chinese state to secretly amass over 20,000 tonnes by 2002, through a process of gradual accumulation. As to whether they did so, we must look at the evidence from China’s gold strategy.
- Source, James Turk's Gold Money
