The timing of America’s announcement on new tariffs is circumstantially connected with China. In an announcement of enormous importance, a date has finally been set for trading in oil futures denominated in yuan. China’s suppliers of roughly 8.5 million barrels of oil per day are agreeing to take yuan for their oil, not dollars, and the new futures contract allows them to hedge the yuan into dollars, euros, yen, or even gold.
The threat from China’s move is to the petrodollar’s status, and therefore the near-monopoly the dollar enjoys in international trade. It also allows oil suppliers to hedge into gold through matching yuan-gold futures in Hong Kong and Dubai, which are physically deliverable. These two exchanges, in consultation with Singapore and others in Asia, are setting up a gold corridor with vaulting facilities with a 1500-ton capacity in a free-trade zone in Qianhai on the Chinese mainland. This move is almost certainly connected with anticipated physical demand for gold arising from the new oil futures contract.
For the first time since the Nixon shock in 1971, there is an important rival to the petrodollar in the form of a yuan alternative. The kicker is the yuan will be partially convertible into gold through matching futures, avoiding the dollar entirely. And it was gold that successive US administrations have feared posed the greatest threat to the supremacy of an unbacked dollar.
There have been some misunderstandings as to China’s currency objectives. They are not, as some would suggest, an attempt to set up a rival to the dollar, or for some long-term plan for the yuan to become a reserve currency. The answer is simple: it’s about control over her own affairs. Using dollars, all transactions are cleared in the American banking system through correspondent banks on a net basis. In theory, this gives America privileged information on China’s trade flows, and the ability to interrupt them, as she did with Iran and Russia.
Anyway, if China wanted to establish the yuan as a reserve currency, or a currency commonly used for trade settlement between non-Chinese partners, it would require a substantial and sustained increase of yuan in international circulation. The Chinese government certainly does not intend to run the trade deficits necessary to produce the extra currency required to rival the dollar. The more likely policy is for state-owned banks to ensure there is reasonable yuan liquidity for the new oil futures to gain traction.
The threat to the petrodollar is very real. The importance to America of the petrodollar is at the very least suggested by the unhappy fates of those who wished to create alternatives: Saddam Hussein, who planned to accept euros and Muammar Gaddafi, who proposed a gold-backed African currency, are well-known examples. Iran, as reluctant to accept “Satan’s currency” as America is to permit her to use it, is for US foreign policy still a work in progress with military intervention actively under consideration.
Bullying China to use dollars is obviously not an option for America, nor can she force China’s major suppliers to only take dollars for oil. But she has chosen to protest the move, by aiming tariffs at China, tariffs that seem certain to be extended to others and even increased. But that’s not all that’s involved in this story.
Quietly, the Indian Ocean has Become China’s
It’s not only in trade that China threatens America’s supremacy. President Trump decided to withdraw $2bn in military aid from Pakistan, effectively freeing Pakistan to align herself closely with China. The latest word is that China is now looking to set up a military base at the Pakistani town of Jiwani, about 50 miles west from the new port of Gwadar, which is the terminal chosen to link the Indian Ocean with the overland silk road. Jiwani is very close to the border with Iran, and well-placed to control the approaches to the Straits of Hormuz, the pinch-point at the entrance to the Gulf.
China also has a military base at Djibouti, commanding the entrance to the Red Sea, and therefore Suez. She has built a new railroad from Djibouti to Addis Ababa. Meanwhile, India, which is disputing China over their common border, and contesting Pakistan over Kashmir, has missed out on Asia’s silk road projects. Instead, she is developing Chabahar Port in partnership with Iran, just over the border from Jiwani, giving overland access to Afghanistan and Central Asia.
India already has several trade and investment agreements with Iran, which gives her the diplomatic pass to pursue this north-south link into Afghanistan and Central Asia in partnership. It gives the convenient appearance for India of setting an agenda separate from that of China and Pakistan. But this is little more than politics for Modi’s home crowd, with discussions rumored behind the scenes for Gwadar and Chabahah to work together as a major hub from the Indian Ocean into Central Asia.
China is also replacing the old Lunatic line from Mombasa on the Kenya coast via Nairobi to Kampala in Uganda, and eventually extending it to Kisangani in the Congo and Bujumbura in Burundi. Separately, there will be a line from Lamu on the coast to Juba in South Sudan. Not only will China be able to freely transport valuable raw materials from the heart of Africa, but investment in agriculture will also provide her with food security.
The Indian Ocean has therefore become the most important geopolitical asset for China outside Asia, with few realizing it has happened. It is clear that China will command the important shipping routes in the Indian Ocean, while America has to be content with its base at Diego Garcia, some 4,000 miles to the south of Hormuz.
Now that China is close to controlling her most important shipping routes, she is now ready to step up her demands that purchases of oil and other commodities must be paid for in yuan. This is why she must now prioritize the financial markets her suppliers will require.
China Is Also Reducing Dependency on US Trade
The days when China was the cheapest cost-base for labor in manufacturing are over. Manufacturing for export markets is being increasingly mechanized, lowering unit costs and releasing labor for future expansion in other higher-value industries. The Communist party’s plans include the upgrading of infrastructure and the transition of the economy towards serving the growing middle classes. Together with proposals to extend her own industrial revolution into the wider Asian landmass, the full transition will probably take up to twenty years. This is the reason, according to the better-informed China experts, that the National Party Congress currently being held is doing away with the limit on the duration of Xi’s presidency, so that he can complete the plans of which he is the principal architect. It is not, as reported in Western media, only the glory for Xi of being a dictator for life.
This year’s NPC, in granting Xi the facility to oversee his plans, fully endorses them and their progress. The move away from depending on cheap exports to America and elsewhere is likely to gain momentum, reducing the relative importance of Trump’s tariffs. Instead, China is creating what amounts to a large free trade area throughout Asia with her partners in the Shanghai Cooperation Organisation. This is the opportunity offered to other foreign suppliers to the region, such as the UK, assuming she has the gumption to become involved after Brexit.
America’s trade wars could have unintended consequences. They could end up with the two economic titans, the US and the EU, imposing destructive tariffs against each other. The effect on both economies will be to simply increase prices for consumers, when other price-inflationary factors are also coming into play.
Fortunately for the rest of the world, the days when the dollar was tied to gold and trade protectionism by America threw the world into the 1930’s depression no longer apply. The dollar can be expected to decline instead of commodity prices falling, as they did in the depression. The impact of America’s protectionism on the global economy today is therefore likely to be significantly less than following the Smoot-Hawley Act. But from an American standpoint, the principal victim of the trade war that commenced this week will be America herself.
