China is planning to bring back gold
standards for international
payment after several decades. Being the world's largest importer of yellow metal, China is now preparing to launch an oil
futures contract denominated in yuan
and redeemable in gold.
While the yuan
is not yet a global trade settlement currency, China will make the plan possible by backing the yuan
for settling crude oil
imports. China is also the largest importer of crude oil.
So far, globally, the dollar has been a major currency to pay for importing crude oil.
China's plan to import oil
backed by gold
would be a game changer as gold
would become the de-facto payment standard despite the fact that all contracts might not finally be converted in gold.
contract, to be traded on the Shanghai International
Energy Exchange, will be China's first futures contract that is open to international
firms for trading. There is no official word on when the contract will be launched but testing has been underway since July.
Nigam Arora, an international
market analyst and author of the Arora Report, said, "China's move is the beginning of gold
standards 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
has the potential to go up by several folds."
Another implication of the Chinese contract would be that it would create a new oil
benchmark. Currently, Brent and WTI are two different benchmarks accepted globally for crude oil.
Nigam said, "If this initiative is successful, it will create a new benchmark similar to Brent Crude and West Texas Intermediate in oil.
As 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
jumps many folds, the situation will change."
According to the World Gold
Council's data, the Chinese central bank holds 1,842.6 tonnes of gold
as part of its reserves, although the yellow metal's share in China's total foreign exchange reserves is just two per cent. The US is the largest holder of gold
with 8,133.5 tonnes in reserves. If the International
Monetary Fund's holding is not considered, China is the fifth-largest gold
holder in forex reserves, according to the WGC. WGC data show that in 2016, China's gold
demand stood at 915 tonnes, compared to India's demand of 666 tonnes.
Till date, the US has been surviving on dollar-based settlements for oil
and other trade. For completing any international
deal, even those not involving the US, the buyer first had to buy dollars to pay for imports. The euro has assumed a distant-second place for international
Surendra Mehta, the national secretary of the Indian Bullion & Jewellers Association (IBJA), said, "China is looking to upset the current petrodollar system by introducing gold-backed 'petroyuan' oil
futures contracts. Since China is the largest importer of oil
globally, this massive shift away from the petrodollar could be bad news for the US. However, it could be great news for gold
China has always had an interest in getting away from the dollar. In the past, their attempts have not been successful. The present initiative is inspired by US sanctions against Russia and Iran. The US has been successful in enforcing the sanctions because it has a large degree of control over the flow of dollars through the banking system. Getting away from the dollar is the best way to evade US sanctions.
However, drawing attention to some issues that might come up, Mehta said, "Despite rising concerns around the US dollar's stability and viability, the yuan
is still too illiquid and un-established globally in comparison, causing many exporters to shy away from accepting it." After convincing Russia, China had also attempted to deal with Saudi Arabia for yuan-based oil
settlement but it didn't receive a positive response. Hence, Mehta said, "China is taking things one step further with these new gold-backed futures contracts. Gold
solves the petroyuan's concerns. Russia welcomed the petroyuan with open arms. While on a standalone basis, the yuan
might not be considered acceptable like the dollar, gold
backing hedges that concern."
prices will spurt if China's contract succeeds when implemented. Will India's prices go up too? If China’s contracts succeed, the dollar will weaken and, as a result, the rupee will strengthen. Gold
prices will shoot up sharply but the rise in Indian gold
price will depend upon how much the rupee strengthens, said Mehta.