China, Russia and Gold vs. the Dollarised World

Paul Goncharoff

Trending and gaining traction throughout the economic world is the increasingly relevant search for safe and secure alternatives to the U.S. dollar. Some due to geopolitical reasons and pressures, others from recognising the significantly deepening debt associated with the dollar and government. Many have started questioning and doubting aspects of its sustainability and inviolability over the ballooning short and long term.

Others are looking to innovative crypto ideas in the hope that extra-governmental blockchain backed mechanisms of peer-to-peer ‘agreed value’ may be the unhindered path to securing wealth. In short, all of these approaches are looking for the security which gold together with similar recognised assets like silver have provided and assured since the dawn of our varied successive civilisations.

China, Russia, Turkey and quite a few others see themselves sanctioned, shackled and hindered by the overwhelming market dominance of the American currency and the quickly changing policies linked to it by successive U.S. administrations most especially of late. Some refer to this as the abnormal ‘weaponization’ of the U.S. dollar as this millennia’s sad new normal.

The tariffs introduced by the American government as a form of behavior modification for other nations are understandably unappreciated and are increasingly resisted. It is likely that a worsening currency tiff is in the cards. The Chinese yuan is gaining internationally among users. Russia, Turkey, and Iran are making payments in their national currencies. Iran recently announced a switch from the dollar to the euro as its reporting currency. Russia and China already have a currency swap agreement that avoids settlements in the greenback. Even Saudi Arabia will have to make a choice probably sooner than later, to stay with the petrodollar fix, or go with its biggest customer – China and therefore the yuan.

China is Russia’s largest trading partner with 15% of Russia’s international trade for 2017. This year is has grown to 17.2%. In 2014 just 2% of payments for Russia’s exports to China were paid in roubles, and 9% of China’s exports to Russia were paid in yuan (renminbi). In 2017, this has increased to 9% and 15% respectively and continues to grow.

There is persistent speculation and growing talk in the financial markets that Russia and China have been in ongoing discussions to expand the role gold, silver and possibly other hard assets might have in realigning the value of both the yuan and the rouble independently of the US Dollar. So far it remains in the realm of rumors, then again that too is a start.

There are a number of countries, which no doubt are paying close attention to what may develop. Some to join and some to try to spoil the party. However this plays out, such shifts will not be smooth or pleasant as the effects are global and will resonate throughout all financial systems, especially within the United States.

It is no secret that the central banks in China, Russia, Turkey, India and some other nations have been steadily increasing their physical gold holdings, as well as repatriating their bullion from the United States, for example Germany, and Turkey just recently this past April.

There are persistent and growing unconfirmed rumors here in Moscow that both Russia and China have formulated or are outlining plans to launch some form of a gold-participatory currency system to replace the greenback as the world’s dominant currency. Whether it will be using roubles or a yuan, or something entirely different is still unclear, but something interesting is no doubt afoot within this fog of speculation..

That being said I have no idea how such a system might actually look, it’s organizational profile, how it would be regulated, standardized and traded, or whether it would be a basket of hard assets (gold, silver, energy) securing it, or only gold. The key attractor for the financial world which has traditionally parked its funds in U.S. dollar government bonds, is if an alternative currency system is governmentally supported, asset backed and interest bearing, then the appeal of that added value and security should make such an alternative realistically appealing. It may be the single key factor which will allow any chances for real competitive use against the dollar, yen, reminbi and euro, all of which are fiat.

Backing currencies today exclusively with gold is highly unlikely; however, there is realistic potential for a new form of currency possibly connected with a state regulated blockchain crypto-currency concept, or the partial exchange within such a currency system for gold as its referenced anchor. These do have possibilities and can occur without unduly testing credulity or imagination.

The trend towards de-dollarization is happening, of that there is little doubt. Equally true is the fact that today this is just an irritant to the U.S. government and the Federal Reserve. If implemented, it will in time erode the foundation and ability the U.S. can bring to bear economically, militarily and politically to all corners of the world through the global financing of its dollar debt. That would be more than just an irritant for the U.S.

No major country currently backs its currency with gold, but many have in the past, including the U.S. The U.S. effectively abandoned the gold standard nationally in 1933, silver in 1968, and completely severed any linkage between the U.S. dollar and gold internationally in 1971. The U.S. since then has remained a fiat money system, meaning the dollar’s value is not linked to any independently redeemable asset other than faith in the U.S. government.

Looking back, the inflection point for the U.S. to begin dollar de-linkage from gold and similar assets was to help combat the Great Depression. Faced with mounting unemployment and spiralling deflation in the early 1930s, the U.S. government found it could do little to stimulate the economy. To deter people from cashing in deposits and depleting the gold supply, the U.S. and other governments had to keep interest rates high, but that made it too expensive for people and businesses to borrow. Therefore, in 1933, FDR cut the dollar’s ties with gold, allowing the government to print (‘QE’) dollars into the economy, thereby lowering interest rates.

The U.S. continued to allow only foreign governments to exchange dollars for gold until 1971, when President Nixon abruptly ended the practice. It is worth noting that before delinking from gold, the dollar had a fixed value reference of $35 to an ounce of gold, which limited and severely constrained financial and political policies. The value of gold was not permitted to be set by an open free market. Only after the dollar delinked from gold was the metal allowed to be openly traded as a commodity, at that time notably via the London Fix, and New York COMEX.

It is unlikely that a fully gold-backed currency mechanism will emerge onto the world financial markets as it was before 1933, especially in this interconnected economic and information age. However, a basket of hard assets as a reference point or linkage anchor to currencies does have traction, and may very well be what is now being discussed between China and Russia. The market can and will establish relative values indexed to the assets comprising such a basket, and not be limited to a single fixed price. This also suggests that some control may shift away from the central banks and instead become market sensitized and responsive. This can be a frightening concept, as it is a distinct departure from today’s central bank, Fed practices, and will require significant political realignments.

Russia and China have been in working discussions to introduce gold-backed futures and similar mechanisms to circumvent the U.S dollar. It may be that over the next few decades we may witness the demise of fiat currencies such as the U.S. dollar, yen, euro and the political excesses non-asset backed money has encouraged.

Currently, with geopolitical pressures, sanctions and trade tariffs increasing against Russia and China, these two countries have come to be seen as the standard bearers or ‘white knights’ for de-dollarizing global free trade. Whether they want this role foisted on them or not. This view is growing within a number of countries who have been limited and constrained from development by the dominant default role of the U.S. dollar, and by extension the U.S. government in its follow-on ability to dictate policies and put pressure on their sovereign national affairs.

The creation and introduction of a gold-inclusive indexed currency mechanism appears to be a likely event, perhaps sooner than we think. Russia has openly said that its national interests can be best served by reducing its exposure to the vulnerabilities and volatilities of global geopolitics by reducing the role of the greenback in its economic affairs.

Moscow and Beijing have been actively reducing their dependence on the dollar in mutual and regional trade. In October 2017, China launched a PVP payment system for transactions in yuan and Russian roubles. This means that payments for Russian oil deliveries to China, which have reached 60 million metric tons per year and continue to increase, are now working without the U.S. dollar as an intermediary mechanism. This also has the added benefit to allow confidentiality of transactions. This is not possible if the U.S. dollar is used as the medium for trade as currently all such transaction details have to be cleared, therefore known in New York.

China’s launch of its own oil futures on the Shanghai International Energy Exchange plays a de-dollarization role and supports the gold-asset function as well. Today, shifting the China oil trade out of dollars into yuan takes between US$ 600 billion and US$ 800 billion worth of transactions out of the dollar each year.

One of the several factors supporting the creation of a Russia/China gold related currency system is that just the other day the global debt reached US$ 237 trillion.

The IMF warned this past week that the debt burden of the global economy is deeper today than it was before the financial crisis of 2008. The latest numbers for global debt is US$ 237 trillion, up from the US$ 140 trillion before the 2008 financial crisis. It is also worth noting that according to the Bank for International Settlements (BIS), there is also approximately US$ 750 trillion in additional debt outstanding in derivatives, much of which is formally still ‘on the books’ but practically can be considered swept under the financial rug, at least for now.

U.S. Debt in 2015

Global debt has increased by roughly US$ 21 trillion in 2017 alone. That is roughly the equivalent of this year’s U.S. national debt. This has led to a forward-looking undercurrent of anxiety in the world’s markets, and a growing desire by some countries to do something to pre-empt being terminally caught up in these increasingly uncertain, predominantly dollar denominated risks.

The latest sanctions against Russian oligarchs and their companies, as well as trade tariffs against China are also having unintended consequences. Rusal is a major aluminum producer. They provide an estimated 6% of the world’s supply. Companies are now scampering every which way to secure new supply sources because the Russian supply has been cut off by U.S. sanctions. The sanctions caused both the Russian stock market and the Russian rouble to fall sharply and sent aluminum prices soaring. This simply underscores the need to create alternatives to the US Dollar sooner rather than later.

Unintended consequences do not stop with sanctions against Russian companies. The dollarized trade war between China and the U.S. is also enjoying its moments in the sun. After the U.S. imposed tariffs on China that hit aluminum products, robotics, aircraft parts, vaccines, dishwashing machines and many other items, the Chinese retaliated in turn with tariffs that hit soybeans, cars, and chemical products among others.

China’s response negatively affected agriculture products notably from the very same agricultural states that backed Trump. Aircraft parts and engines were a top U.S. export to China, totaling some US$ 16.3 billion. Soybeans are a top agriculture product with US$ 12.4 billion exported to China every year. As this evolves, we should be seeing inflation in the U.S. and elsewhere rather higher than the Fed’s ‘2% sweet spot’, in fact it may unpleasantly surprise us all.

Keeping in mind when loans are made in dollars, the debtor is then essentially a hostage, having to agree to the issuing central banks’ policies. The central bank determines the price of those dollars through politically guided monetary policy, and its (fiat) value thanks to currency printing. If such loans were issued in gold or asset-backed instruments, such counterparty pressures would lessen, or no longer be a feature.

China for many years has made it clear that gold purchased in China is to remain in China. Russia, Turkey and recently India are of the same conviction. This allows for each of these nations to be the secure custodian and guarantor of their gold assets, reducing the risk of politically motivated seizure as can happen with currencies and debt instruments.

Decisions have been acted on already by several countries repatriating their gold from the U.S. This is a telling sign that U.S. control and influence is starting to shift, along with trust that had allowed the U.S. to play a custodial role over foreign reserves for so long.

Russia, Turkey and China are countries that are increasingly seen as threats by the West, in one form or another, and are rocking the currency boat. Various measures have been taken against them to make international trade and negotiations onerous at best. Whether through fear mongering, sanctions or trade tariffs, countries are feeling the force and weight of the U.S. and its allies’ powers. As a result, they are increasingly considering re-enlisting gold and perhaps a basket of similar assets to shield themselves and protect their financial reserves, and their ability to function as economically viable independent sovereign nations.

The process has begun, where it may take us over the coming years is the big question and one that will redefine international trade and geopolitics for decades to come. While today this possibility is still in the realm of market hearsay, rumours, and fake news – but in this increasingly curious age what isn’t?

Print Friendly, PDF & Email