A New Challenge to the Dollar

In a move that was little noticed outside of the financial world, China announced the creation of an oil futures contract (open to international traders) that will be denominated in Yuan and convertible into gold. This move provides the first official linkage of oil to gold, and more importantly a linkage between the Chinese currency and gold. While the contract volumes that will be traded on this new platform will certainly be minuscule in comparison to those in the dominant markets of New York and London (at least initially), I believe the move is the latest, and perhaps most significant, step that China has taken down the path that could lead to a global economic system that is not fully dependent on the U. S. dollar. The move amounts to a direct challenge to the dollar’s privileged reserve status and could threaten U. S. dollar price erosion.
The move comes at a time when the U. S is particularly vulnerable to an economic challenge. Given the bold, but not particularly diplomatic, efforts of the Trump Administration to push an America First agenda, the U. S. finds herself somewhat isolated. Add to this the widening political polarity in the U. S., which will make it that much less likely that Washington can take needed action in passing economic reforms to prevent a looming debt crisis. The dollar has been neglected far too long, and its strength may be far more tenuous than many imagine.
By way of background, the United States emerged from World War II as the world’s undisputed economic, financial and military leader. In 1944, at Bretton Woods, the U. S. dollar, convertible into gold exclusively by central banks, was adopted as the world’s main reserve currency. This status meant that the dollar was used to price most commodities, used to transact nearly all international trade. This status further strengthened the dollar and helped make Americans the richest people in the world.

This post was published at Euro Pac on September 28, 2017.