China buys oil with Yuan, not Dollars

[Felix]

Thanks to workathome for bringing this up in the Gold crash thread.

This is potentially huge.

http://www.examiner.com/article/dollar- ... using-yuan

Does this mean that the Dollar loses (or even already lost) reserve currency status?

If I understand it correctly, this move by China will drastically decrease the exchange-value of the dollar.

[susswein]

Did you notice that the article was dated a year ago (september 2012)?

[Chad]

No one has Yuan to buy the oil with and the Yuan doesn't float yet. While, it's one more step towards China being a legit economic superpower, it's just that...one more step.

Also, why does there have to be only one reserve currency? If the Yuan/China ever succeed at creating a reserve currency, that does not mean the Dollar loses it's status as a reserve currency. The Dollar has a greater chance of losing it's status as reserve currency by what the US does than by what China does.

[anomie]

Surely China will be careful how it plays this.. China is itself heavily invested in US Dollars:

...The largest foreign holder of U.S. debt is China, which owns more about $1.2 trillion in bills, notes and bonds, according to the Treasury. ...

In total, China owns about 8 percent of publicly held U.S. debt. Of all the holders of U.S. debt China is the third-largest, behind only the Social Security Trust Fund's holdings of nearly $3 trillion and the Federal Reserve's nearly $2 trillion holdings in Treasury investments, purchased as part of its quantitative easing program to boost the economy.

http://usgovinfo.about.com/od/moneymatt ... na-Own.htm

[jacob]

This seems similar to Iraq approving sale of their oil for EUR, uh, coincidentally, just before they got invaded in 2003. Now it's back to dollars.

It seems that having your currency tick the "petrodollars" box does hold some value.

[workathome]

To make it even more interesting, China agrees to SELL oil as well without dollars. So China could be a safety proxy for countries looking to hedge out of USD.

[vivacious]

This seems similar to Iraq approving sale of their oil for EUR, uh, coincidentally, just before they got invaded in 2003. Now it's back to dollars.

It seems that having your currency tick the "petrodollars" box does hold some value.

That's exactly right. Petrodollars are a huge issue.

[Riggerjack]

Seriously? Quoting an Alaskan minister for international monetary intrigue?

I'll be the first to admit there are issues with the dollar, but a deal made in Yuan is not going to break the fed. The fed will break the fed. In the meantime one could make an oil deal with marshmallow futures, if one could find an oil tycoon with a hankering for fluffernutters.

Oil is dealt in futures, because it is a commodity that must be shipped, by dedicated ship. The US dollar is stabil-ish, and well known. Shenanigans of monetary policy are relatively transparent. Futures prices are volitile enough without throwing in risks of less transparent currency. That being said, price in the risk, deal in whatever currency will be accepted.

Not knowing the particulars of the deal, this sounds more like a Chinese businessman has less faith in the Yuan holding value than the dollar. This coincidently, corresponds to other reports of monetary crisis in China I've read recently.

[Felix]

From my understanding having to get dollars to get oil keeps up demand (and thus relative value) of the Dollar (since everyone is addicted to oil). If you look at the chart from last September of Dollar vs. Oil the price moved up.

Might be something else entirely, though.

The fact that things fall to the ground does not prove that magical unicorns pulling them down exist. One can usually find at least 5 different theories explaining a phenomenon and one is easy to fool.

[Riggerjack]

Well, China buying oil with dollars increases the dollar to Yuan demand, but decreases the dollar to vz peso, or whatever currency is used by the seller. If the buyer and seller are using dollars, it is net nuetral to currency flow.

That being said, buying oil with Yuan does make you wonder what is being done with excess trade dollars China has. In the past, trade deficit was reinvested in tbills, then oil, and south American and Australian imports. China isn't buying up as much raw materials anymore. So what are they doing with those stacks of dollars?

On a different note, The benefits of reserve currency are doubious and hotly contested by economic bloggers. I have yet to see a solid case one way or the other, and I've read allot of them. They always break down when you consider the flip side to their arguments.

So long as we maintain solid import/export numbers, and avoid serious currency crisis, the dollar will be a reserve currency.

[Felix]

Could not other countries also buy Yuan instead of Dollars to buy oil? This would affect the exchange rate of other currencies as well. I'm not sure about this, though.

I also wonder what China wants to do with those dollars, then. They have already built up a large dollar reserve.

[Chad]

Could not other countries also buy Yuan instead of Dollars to buy oil? This would affect the exchange rate of other currencies as well. I'm not sure about this, though.

I also wonder what China wants to do with those dollars, then. They have already built up a large dollar reserve.

You could, but then you couldn't buy anything else unless it was from China. Plus, the vast majority of oil is still denominated in Dollars and I would bet, I haven't researched it, the country that uses Yuan to denominate oil also uses Dollars.

China probably wants to lower their reserve of Dollars and work towards the Yuan as a reserve currency or at least a 2nd tier reserve currency. Though, I don't see how that is possible until it floats.

[Riggerjack]

Country A using country B's currency to buy oil from country C is fairly neutral for country B's Currency. Equal numbers in and out. Now there's a slight positive effect for country B's exchange rate with A and negative with C in this arrangement. In this case, China using Yuan to buy oil gives a tiny boost to the Yuan side of the Yuan dollar exchange rate. Before anyone says "ah hah!!!", China has been artificially depressing that exchange rate for decades, to boost its exports. That's A big WTO issue, and the source of conspiracy theories and get rich quick schemes. Google to your hearts delight.
I still think this is a Chinese business hedging Chinese inflation. But I've been wrong before.

[workathome]

Related:

...two things happened in China yesterday, that make me believe they are stepping toward that replace of the dollar standard, with a quicker pace. First, yesterday we had China announcing that they will launch Certificates of Deposit (CDs) which can be traded in the interbank market in the near-term. This is HUGE folks. I know, I know, it looks to be a really dumb thing to hang one's hat on.

The second piece of news from China is an even bigger pink elephant in the room. China has announced that they are going to test convertibility of the renminbi / yuan in a free-trading zone being established in Shanghai. Remember that back in May (OK I know you don't, but pretend you do) the Chinese Gov't announced that it would propose a plan this year on capital account convertibility. The 29 square kilometer free trade zone in Shanghai, will set up a foreign exchange management system, for Chinese banks to do offshore business and facilitate trade and investment.

...So, the Chinese appear to be moving ahead of schedule on making their currency available as the new reserve currency replacing the dollar standard.

[Felix]

Country A using country B's currency to buy oil from country C is fairly neutral for country B's Currency. Equal numbers in and out. Now there's a slight positive effect for country B's exchange rate with A and negative with C in this arrangement. In this case, China using Yuan to buy oil gives a tiny boost to the Yuan side of the Yuan dollar exchange rate. Before anyone says "ah hah!!!", China has been artificially depressing that exchange rate for decades, to boost its exports. That's A big WTO issue, and the source of conspiracy theories and get rich quick schemes. Google to your hearts delight.
I still think this is a Chinese business hedging Chinese inflation. But I've been wrong before.

Isn't the whole idea behind the petrodollar that you buy the oil directly with dollars. This means there is no currency C in your example, only many currencies being traded for dollars to be finally traded for oil, keeping the dollar exchange rate up.

Or am I misunderstanding this somehow?

[Felix]

Related:

...two things happened in China yesterday, that make me believe they are stepping toward that replace of the dollar standard, with a quicker pace. First, yesterday we had China announcing that they will launch Certificates of Deposit (CDs) which can be traded in the interbank market in the near-term. This is HUGE folks. I know, I know, it looks to be a really dumb thing to hang one's hat on.

Can you elaborate a bit more on this and how it works? What are these CDs to be traded in the interbank market and why do you believe this is a big deal?

[workathome]

@Felix - Sorry, not me. Chuck Butler. He has some more explanation regarding the CDs I cut out. It's not up on the Daily Pfennig website yet, but was in this morning's newsletter.

Why am I telling you this? Because two things happened in China yesterday, that make me believe they are stepping toward that replace of the dollar standard, with a quicker pace. First, yesterday we had China announcing that they will launch Certificates of Deposit (CDs) which can be traded in the interbank market in the near-term. This is HUGE folks. I know, I know, it looks to be a really dumb thing to hang one's hat on. But think about this from a bank's point of view. having CD's that are traded, and can be traded before maturity date in the international market, provides a ton of liquidity. The People's Bank of China (PBOC) said that they are also going to push for forward rate liberalization. (remember I've explained the forward rates in China before, but for those of you who missed class the 100 times I've explained this before. forward rates in freely traded/ convertible currencies is usually equal to the interest rate differential and the number of days between the two currencies being traded. But with China, India, Brazil and others, they are non-deliverable forwards, of which traders also speculate where they think the currency will be at the forward date in the future. China would have to get more trading desks around the world to take positions and deal in the renminbi/ yuan before this could be achieved, but it's nice to think they are thinking of this)

Butler's Daily Pfennig is where I originally read about China selling and buying oil without the USD as intermediary.

[Riggerjack]

Country C ends up with dollars and less oil. While dollars make a nice green wallpaper, a more common use for them is to trade them for goods and services. Doing so in goods that go back to country C, or services rendered to or for country C will be paid for with those dollars. That flow of goods and services one way is what applies the exchange pressure.

The exchange rate changing is the counterbalance to trade deficits. Unions will tell you that China holding their currency artificially low is an attack on American manufacturing. It's really more of a Chinese subsidy of Chinese exports. Restricting the exchange rate is causing the Chinese people to have fewer imported goods and services than would be available otherwise.
No central banks anywhere are holding Yuan in reserve. China has economic issues hidden under it's economic issues. The whole Chinese superpower image is just union leftist scare tactics. They may be legitimately scared,but that doesn't make them any better at predicting the future.

[Felix]

@Riggerjack:

Maybe I'm especially dense today. Still don't get it.

How does Country C's currency enter the picture. Imagine the alternative scenario that Country A simply buys oil from country B. Then the oil flows to A and the exchange rate between A and B is affected. Country C is out of it.

If country C is supplying the oil but paid in the currency of country B, isn't that the same?
Someone sold oil and now has dollars in his hand. Does it really matter where he is sitting?

If an American oil mogul sits in Saudi Arabia and orders something in dollars, does this affect the US Saudi Exchange rate? I do not see how.

I also do not see how does this change when it is a Saudi oil mogul with dollars in his account.

Isn't the exchange rate only affected when currencies are actually traded?

@workathome:

Thanks. I'll need to research this a bit more. Still don't get it. Damn, I really seem to be especially dense today.

[workathome]

It all seems pretty esoteric to me too.