Sorry folks, but there is no Chinese alternative to the petrodollar

‘Those who foresee in the pipeline a petroyuan to effectively challenge the hegemony of the petrodollar are ignoring the practical realities of the global financial system’

PUBLISHED : Tuesday, 31 October, 2017, 10:15am
UPDATED : Tuesday, 31 October, 2017, 10:47pm

An emergent petroyuan to rival the petrodollar might appeal to those who resent Uncle Sam’s enjoyment of the privileges that accrue from the world having to hold greenbacks to pay for its oil and gas. It might also undermine the global reserve status of the US dollar. The only problem is that in practical terms the idea is a non-starter.

It might not be fashionable to admit it but the world’s global monetary system rests on a bedrock of US dollars, while so central to the US national interest is the dominant reserve currency status of the greenback that Washington could hardly be expected to cheerfully acquiesce to an erosion of its currency’s hegemonic status.

As regards the global monetary system, as the Bank for International Settlements (BIS) has reported, at the end of March there already existed some US$10.7 trillion of on-balance-sheet debt being held by companies and governments outside the United States.

Additionally, in September the BIS also said there could be another US$13 trillion of debt held off-balance-sheet.

The bottom line is simple. Those who have borrowed in US dollars will have to repay greenbacks to the lenders, not any other currency.

It’s a matter of historical fact that when the plumbing of the global financial system seized up, as it did during the Global Financial Crisis, it was only an injection of US dollar liquidity that helped solve the problem.

“Markets calmed only after coordinated central bank swap lines to supply [US] dollars to non-US banks became unlimited in October 2008,” the BIS said.

It’s also worth noting that while last week’s US dollar bond issue by China, with its international nature reflected in the fact that it was issued in Hong Kong and governed by English law, was hugely oversubscribed, a key objective of the issuance was to establish a pricing benchmark for Chinese state-owned entities who are already prominent issuers of US dollar-denominated bonds in the offshore market.

But even though there’s a wealth of evidence attesting to the continuing and deep-rooted dominant position of the US dollar in the smooth functioning of the global financial system, that doesn’t mean other currencies couldn’t rise to challenge it.

The euro, which might logically have been seen as a competitor to the US dollar, hasn’t really challenged the greenback’s global currency hegemony, but that doesn’t mean the yuan couldn’t, especially if Middle East energy producers could be persuaded to accept the yuan in exchange for their oil and gas.

But why would Middle East energy producers want to do that given that their own currencies are pegged to the US currency, as indeed is Hong Kong’s.

The French bank Credit Agricole CIB (CACIB) recently published a new edition of their Middle East and North Africa Capital Markets Guidebook that clearly illustrates the situation.

As regards Saudi Arabia, “the Saudi Riyal has been pegged to the USD at a rate of SAR3.75 per USD1 since 1986. The USD peg is highly political and no changes are expected in the medium term,” CACIB wrote. In the United Arab Emirates the UAE dirham “ is pegged to the USD at 3.6720-3.6730 (bid offer) and has been since 1980” while in Qatar the Qatari riyal “is pegged to the USD at 3.6400,” the French firm wrote.

As regards monetary policy, benchmark interest rates in Saudi Arabia and the UAE closely track US rates as set by the Federal Reserve.

With such close links to the greenback, it’s hard to envisage these energy producers materially embracing a petroyuan when the handling of those yuan flows would only complicate the management of their existing financial systems.

And then there is the geopolitical and military imperative that underlies the Middle East’s pricing of energy in US dollars.

In 1973 the United States and Saudi Arabia signed an agreement, later extended to include other nations in the region, which allowed those countries protection under the US military umbrella in return for a commitment to only price oil in US dollars.

With that strategic stance still as relevant in 2017 as it was in 1973, and with the intervening decades having seen the financial architecture of countries such as Qatar, Saudi Arabia and the UAE become increasingly linked to the US dollar, it would arguably take an awful lot to persuade those Middle East countries to move away from the petrodollar.

Those who foresee in the pipeline a petroyuan to effectively challenge the hegemony of the petrodollar are ignoring the practical realities of the global financial system. Theirs is a pipe dream.