By Levi Lippincott
It was September 6th, 2012 that our world changed dramatically and virtually no one reported the news. No, not the news that President Barack Obama officially accepted the nomination for presidential candidate on the Democrat ticket. It was that China has setup their own petroleum exchange using their currency, the yuan, instead of the U.S. dollar. Why is this so dramatic and how does it impact your life? To explain this in a way that the severity is properly understood, a refresher on the history of the U.S. dollar and global oil purchases are necessary.
Prior to the Gold Standard Act of 1900 the U.S. dollar had always been a bi-metallic backed currency which meant that a U.S. Mint issued coin had to have a certain weight of gold or silver. The rate was not the same for gold and silver it was just a fixed rate in order to keep a stable value on the dollar. When the Gold Standard Act was passed by the 56th Congress and signed into law by President William McKinley on March 4th, 1900 it demonetized silver and set the dollar to be 25 8⁄10 grains of gold or to put that into an ounce of gold perspective it was a little over $20.67 for an ounce of gold. After World War I the exchange value of the dollar certificates was suspicious because the Federal Reserve System had been established and was required to keep enough gold reserves on hand to cover 40% of the dollars they printed. It was because of this ratio that many people did not trust the printed dollars and held onto their gold coins or exchanged their printed dollars for the gold coins those dollars represented. They were able to do this until President Franklin Roosevelt issued Executive Order 6102 on April 5th, 1933 which prohibited “the Hoarding of Gold Coin, Gold Bullion, and Gold Certificates within the continental United States.” Executive Order 6102 made it illegal for the citizens of the United States to be in possession of any gold or silver that was not jewelry or deemed a collectible. Then on January 30th, 1934 the Gold Reserve Act was passed requiring the Mints to purchase back all gold from the Federal Reserve at a rate of $35 per ounce, thus devaluing the dollar by 59.06%.
Then towards the end of the World War II on July 22nd, 1944 the Bretton Woods system was agreed upon by the 44 Allied nations’ delegates. The Bretton Woods system officially, and effectively, established the U.S. dollar as the world’s reserve currency. It did so by requiring these nations to “peg” their currency value to a fixed dollar exchange rate that could not vary more than 1%. The reason these nations readily agreed to use the dollar was due to the previously mentioned Gold Reserve Act. It ensured that the U.S. Government would convert dollars into gold at $35 which made the dollar as good as gold. Moreover, the dollar was even better than gold because it earned interest and while U.S. citizens could not redeem their dollars for gold these nations could, at any time. Now the Organization of the Petroleum Exporting Countries (OPEC) did not officially exist until 1960 each independent member state did. Prior to the Bretton Woods system these OPEC nations had only accepted gold as a form of payment. With the dollar now being used as a reserve currency in all Bretton Woods affiliated nations the OPEC nations began accepting dollars alongside gold as a form of payment even though officially gold was the only price at which oil was listed in. Then on August 15th, 1971 President Richard Nixon issued Executive Order 11615, more commonly called the Nixon Shock, which closed the foreign gold exchange rate of $35 for 1 ounce of gold thereby removing any last shred of gold standard for the dollar. Suddenly all these nations had nothing backing their currency that was previously pegged to the dollar but worthless paper. Just as the Bretton Woods nations were left holding worthless paper so too were the OPEC nations that had been swindled now that the dollar was “floating” in value compared to gold.
So in September of 1971 the OPEC nations met to discuss the quickly devaluing dollars they now held because they had been selling their oil in dollars to make it easier on their customers and because their customers had dollars in reserve due to the Bretton Woods system. They issued resolution XXV.140 which stated: “Member Countries shall take necessary action…to offset any adverse effects on the per barrel real income of Member Countries resulting from the international monetary developments of 15 August 1971.”
This “necessary action” was the fixing the price of a barrel of oil to a gold rate, thus causing the price of oil per barrel to rise steadily as the value of gold rose. In the end this causes the price per barrel to jump from $3 to $12. The Nixon administration ended up striking a deal with Saudi Arabia in 1973 in which the Saudis would no longer list the price of their oil in gold and instead list in U.S. dollars. The other OPEC nations quickly followed the largest oil exporter’s example which cemented the U.S. dollar, which would have returned to being a local currency, into what seemed to be the permanent world petrodollar and thereby the world’s reserve currency.
So now if a nation needs oil for its citizens it can only buy oil with U.S. dollars, which requires nations to go out of their way to acquire more. This has been the system several generations of U.S. citizens have lived under and what we currently have. It is a system where inflation is slowly felt within the country because a lot of the inflation is exported overseas into the economies of those nations who acquire U.S. dollars.
It is this reserve currency status that has allowed the United States to become complacent and transform from a lender and producing nation into a debtor and consumer nation. No longer were the effects of bad government policies by those on the left or right felt by the citizens. Wars were able to be waged, new entitlement programs created, government expansion, etc. all possible without having to burden the taxpayer. Just print the money and ship it overseas to those needing oil.
With the citizens lacking the pain from these bad policies and reckless spending a cultural shift occurred that slowly stripped away the delayed gratification mentality our forefathers had. No longer should citizens save up and then make a purchase, just use the easily created credit of the printing press. Then as the country began to transform into a debtor nation so too did it begin the shift into a consumer nation. The Chinese are very intelligent and learned that if cheaper goods could be provided then dollars would flow into their coffers making China a very rich country. Now it is virtually impossible to go into any store and not find something stamped “Made in China.” By having their coffers filled with U.S. dollars they were able to start buying up massive amounts of U.S. Treasury bonds. This allowed them to start earning interest by financing the bad policies of the U.S. citizen with dollars sent to them by the same citizens these bad policies are affecting. So now China has setup their own oil exchange in which the Chinese yuan will be the listed currency on the product making it a petrodollar. Interestingly enough China is not an oil producing nation so naturally most have ignored this news because it would be a waste of time, money, and effort to attempt to sell oil when you have limited supplies or none at all. Those ignoring this news are forgetting that China can simply purchase oil from the current exchange using dollars, of which they have massive quantities, and then turn around and sell it using its own currency. By doing this, China can drive up the cost of oil in the dollar exchange and then if they keep their own currency devalued or further devalue it against the dollar, it suddenly makes their exchange more of a viable alternative due to its low cost. If
China were to go that route it would be a very long and costly endeavor so the chances of it occurring are remote.
Then something happened on September 7th, 2012 that made the previously mentioned scenario a very serious matter. Russia announced that for the first time in any oil producing country’s history, they would be supplying China with as much oil they want, with no limits, and will do so not using the U.S. dollar.
What does this mean for the U.S. citizen? It means that if China becomes the world’s new petrodollar, and thus the world’s new reserve currency, all those dollars being held by other nations will be worthless to them. So these nations will suddenly be trying to unload them back into the only place they have any value, the U.S. economy. This will cause inflation on a scale previously unseen in the U.S. and will result in a massive standard of living collapse. There are steps the U.S. could begin taking in order to prepare for and maybe stop the standard of living collapse, but it doesn’t appear that those running this nation are willing. It would mean sacrificing the sacred cows built up on both sides, it would mean massive reductions in government size and scope, and it would require a return to a monetary system that is based on something with a fixed value not just how quickly the printers can run.
Not much changed this election cycle, depending on what party you affiliate with there were some victories and there were some losses. Hopefully all those reelected and all those newly elected will take this problem seriously. After all, we may only get one shot to get this right.
Levi– China keeps its currency pegged to the dollar, so as our currency inflates, so does theirs. A cheaper dollar makes for a cheaper yuan, in lockstep.
Moreover, while they hold much of our debt, the yield on that debt is practically nil. Certainly below the rate of inflation. They have no real incentive to help further devalue the dollar, do they?
There’s an old saying in the banking business. When you owe the bank a lot of money, they control you. But when you owe them a huge sum of money, you control them. No nation wants to be left holding a bag of worthless dollars. Or T-bills, more specifically.
If China drives up the dollar price of oil, then sells that oil in yuan on their own exchange, as you suggest they might, then each subsequent purchase becomes more expensive for them, and every sale on their own exchange is for a yet more deeply discounted yuans.
Of course, they could simply float the yuan and unlink it from the dollar. But, that will make their export prices relatively higher and slow down sales to their huge customer, the United States. Fewer dollars into their coffers.
Gresham’s Law– that gold “seeks its own level” as it corrects trade imbalances, applies to currency as well. Russia can buy oil in yuans, but they still have to obtain those yuans from someplace, ultimately from China.
So, this “ploy” you propose makes no sense. Currency games fail in the long run. If you seek to screw your best customers, then the end game is your loss as much as theirs.
Bottom line: economics is not a zero-sum game.
Our country is lost !! Thank repubs!!!
Roger – I am aware of China’s pegging if their currency to ours. I get so irritated when I hear politicians talking about how China “manipulates their currency” when it is us manipulating our currency and they are just responding.
China does have an incentive to further devalue the dollar if they know their end game is to become the world’s petro dollar. Look at what has happened to our country as a result of being reserve currency status. Sacrificing several $bn dollars is nothing when the end result will net them trillions. At a certain point our currency will become worthless whether we want it to or not if we keep heading down the road we are on. I think China is fully aware of this and they are playing a long game.
Russia does not need to purchase oil in dollars or yuan they are a producer of oil, which is why their unlimited supply of oil deal with China is so scary. They also see the opportunity to screw over their long time enemy and possibly return to Superpower status.
You are correct that currency games fail in the long run and it looks like ours is about to come to an end.
Levi, Roger, You both make valid points. The problem starts with all this quantitative easing. This results in pushing commodities up in price and can force a country to use commodities instead of currencies to do exchanges. The US is printing money in an attempt prop up the economy but this Kenseyian action never works for very long as inflation is the result. Inflation can distort trade. However, for the US, the bigger problem is taxing labor at 15 percent while allowing people to spend 25 percent of their adult life on Social Security. This pretty much forces the government in to role of making funny money.
Finally, I nominate Sasha for troll of the week.
This is almost certainly a marvelous website, I agree with the comments you have. Thank you.
The result will be war – on a very large scale.