China may use gold for trade payments
China is planning to use gold for international payments after several decades. Being the world’s largest importer of bullion, China is now preparing to launch an oil futures contract denominated in the yuan and redeemable in gold.
The yuan is not yet a global trade settlement currency, but China will make this possible by backing its currency with gold for settling crude oil imports. China is also the largest importer of crude oil. So far the dollar has been the major currency to pay for importing crude oil. China’s plan to import oil for yuan backed by gold will be a game changer as gold becomes the de facto payment standard, although all contracts may not finally be concluded in gold.
The oil contract, to be traded on the Shanghai International Energy Exchange, will be the China’s first futures contract open to international firms for trading. There is no official word on when the contract will be launched, but testing has been under way since July.
Nigam Arora, an international market analyst and author of the Arora Report, said, “China’s move is a beginning of the gold standard for trade in a new form. Gold is becoming less of a commodity and more of a currency as the contract is backed by nothing other than gold. If this move takes hold, gold prices could rise.”
Another implication of the Chinese contract is that it will create a new oil benchmark. “It will create a new benchmark similar to Brent and West Texas Intermediate in crude oil. So far as its impact on gold is concerned, there is not enough freely available gold in the world to back more than a few small initiatives. Of course, if the price of gold rises several times, the situation will change,” Arora added.
According to the World Gold Council’s data, the Chinese central bank holds 1,842.6 tonnes of gold as part of its reserves, or 2 per cent of its total foreign exchange reserves. The US is the largest holder of gold with 8,133.5 tonnes in reserves. If the IMF holding is not considered, China has the fifth largest holding of gold as forex reserves, according to the WGC. WGC data says that in 2016 China’s gold demand was 915 tonnes compared to India’s 666 tonnes.
So far, the US has been surviving on dollar-based settlement for oil and other trade. To complete any international deal, buyers buy dollars to pay for imports even for deals not involving the US. The euro has assumed a distant second position in international trade settlement.
Crude oil is the biggest commodity and China is the largest importer of oil. “China is looking to upset the current petrodollar system by introducing a gold-backed “petroyuan” oil futures contract. And since China is the largest importer of oil globally, this shift away from the petrodollar could be bad news for the US but it could be great news for gold owners,” said Surendra Mehta, National Secretary, Indian Bullion & Jewellers Association.
China has always had an interest in moving away from the dollar but previous attempts have not been successful. The present initiative is inspired by US sanctions against Russia and Iran. The US is successful in enforcing the sanctions because it controls the flow of dollars through the banking system. Getting away from the dollar is the best way to avoid US sanctions.
Mehta, however, draws attention to some issues that could crop up. “Despite rising concerns over the dollar’s stability and viability, the yuan is too illiquid and un-established globally, causing many exporters to shy away from accepting it,” he said. After convincing Russia, China had attempted to deal with Saudi Arabia in yuan-based oil settlement but it did not receive a positive response.
“China is taking things one step further with this new gold-backed futures contract. Gold solves the petroyuan concerns. Russia has welcomed the petroyuan,” Mehta said.
Gold prices will spurt if China’s contract succeeds. The dollar could weaken and the rupee might appreciate against it. The rise in Indian gold prices would depend on how much the rupee strengthened, Mehta added.