Many oil futures denominated in yuan were launched on the Shanghai market at the end of March 2018 and quickly traded for 62,500 contracts – hence for a notional value of 27 billion yuan, equivalent to 4 billion US dollars.
The financial process of the new petroyuan, however, had already begun as early as 2016.
Hence there was obviously the danger of an internal financial bubble in China, but linked to the crude oil price – yet the Chinese government had decided that the fluctuation allowed for those contracts had to be only 5%, with a maximum 10% fluctuation only for the first day of trading.
Furthermore considering the average level of oil transactions in China, we can see that oil and gas imports could back financial operations totalling over 200 billion yuan.
According to industry analysts, the level of Chinese oil imports is expected to increase by approximately 2.1 million barrels per day from 2017 until 2023, which implies that the Chinese market will change the future level of oil barrel prices – be they denominated in dollars or in another currency.
Hence, from now on, China will explicitly challenge the “petrodollar” to create its petroyuan – with an initial foreseeable investment by the Chinese government, which will take place on the sale of a 5% shareholding of Saudi Aramco.
Nevertheless the prospect of an IPO on the Saudi “jewel in the crown” – which was also at the core of Prince Mohammed bin Salman’s Vision 2030, all focused on the Kingdom’s economic diversification – has been postponed to at least 2019.
The Saudi Royal Family is not at all homogeneous, both politically and for its different financial interests.
This is demonstrated by the attack – obscure, but thwarted with some difficulty – on Riyadh’s royal palace, launched by some armed units on April 21 last.
Should the sale of a 5% shareholding of Saudi Aramco finally take place, however, it would be the biggest IPO ever.
The magnitude of the deal is huge: according to the latest Saudi estimates, the company is worth 2 trillion US dollars – hence a 5% shareholding is at least equal to 100 billion dollars.
Moreover, China is doing anything to make Saudi Arabia accept payments in yuan – the first step to replace the old petrodollar.
If Saudi Arabia did not accept at least a large share of Chinese payments in yuan, it could be “blackmailed” and witness a decrease in an essential share of its oil exports. Not to mention the fact that – also with reference to Saudi Aramco – as the saying goes, sovereign funds and Chinese state-owned companies have “deeper pockets” than many prospective Western buyers.
Moreover President Trump is doing anything to make the IPO on Saudi Aramco end up in US hands. However, it cannot be taken for granted that he will succeed. In spite of everything, Mohammed bin Salman is not the heir of the old Saudi bilateralism vis-à-vis the United States.
Nonetheless, in his visit to China last March, Prince Mohammed bin Salman already signed contracts with his Chinese counterparts to the tune of 65 billion US dollars – and they are only petrochemical and energy transactions.
Furthermore this major Saudi oil company is considering the possibility of issuing yuan-denominated bonds, at least to cover part of the trade between the two countries.
Moreover, the US imports of Saudi oil have been steadily declining for some time, which makes the US role in the future post-oil diversification of the Saudi economy – the real big deal of the coming years – more difficult.
Over the next few months, however, the Chinese financiers are preparing to launch on the market a yuan-denominated oil future convertible into gold.
According to Chinese sources, it will be open to foreign investment funds and to the various oil companies.
Hence if the use of the dollar is gradually avoided, it will be possible – also for Russia and Iran, for example – to circumvent the sanctions imposed by the USA, the EU and the UN and fully re-enter – precisely through the yuan – the global oil and financial markets.
Moreover, the “petroyuan operation” is rapidly expanding to Africa.
Just recently, we heard about the definition of a three-year currency swap between China and Nigeria worth over 2.5 billion yuan.
As is well-known, the currency swap is a special derivative contract with which two parties exchange interest and sometimes principal in one currency for the same in another currency. Interest payments are exchanged at fixed dates through the life of the contract.
Hence 2.5 billion yuan are exchanged with 720 billion Naira.
Obviously, also in this case, there is no need for either of the two contracting parties to buy US currency for trading and exchanges, while Nigeria is currently China’s largest trading partner in Africa and China is the largest foreign investor in Nigeria.
All this happens in Nigeria, with African exports to China mainly consisting of oil and raw materials, exactly what is needed to keep China’s rate of development (and the yuan exchange rate) high.
The internationalization of the Chinese currency, however, is mainly stimulated by the following factors: the expansion of the cashless economy, which favours large Chinese and global operators such as AliBaba (Alipay) or WeChatPay; the Belt and Road Initiative, which pushes China’s investment and combines it with other monetary areas; the very fast globalization of Chinese banks and their adoption of the SWIFT gpi system; finally the development of the Interbank Paying System between China and the countries with which it trades the most.
Nonetheless there are some factors which still need to be studied carefully.
Meanwhile, Hong Kong is still the largest clearing center for the transactions denominated in yuan-renmimbi – with 76% of all transactions that currently pass through the island still under the Chinese special administration.
Still today the renmimbi account only for 1.61% of all international settlements, while 22 Chinese banks are SWIFT-connected.
Many, but not enough.
Moreover, as much as 97.8% of the yuan trading is still as against the US dollar, while the exchange between the yuan and the other currencies other than the US dollar is worth very little in terms of quantities of cash and liquidity traded.
Still today 80.47% of payments whose last beneficiary resides in China is denominated in dollars.
As to the international renmimbi reserves, it all began when, in September 2016, the International Monetary Fund announced that, for the first time, the Special Drawing Rights (SDR) would include the renmimbi.
In June 2017, the European Central Bank converted the value of 500 million euro into dollars (557 million US dollars) and then into renmimbi – equivalent to 0.7% of the total portfolio of ECB’s currencies, while in January 2018 the German Central Bank decided to include the renmimbi among its reserves.
Nowadays only 16% of China’s international trade is traded in the Chinese currency.
The real problem for the dollar is still the euro.
In fact, the transactions in US dollars fell from 43.89% of total transactions in 2015 to 39.85% in 2017 while, in the same period, those denominated in euro rose from 29.39% to 35.66%.
However, as Vilfredo Pareto said, currencies are “solidified politics”.
In fact, China wants to use the renmimbi-yuan also in the Pakistani port of Gwadar and in its Free Economic Zone, which is the first maritime station of the Belt and Road initiative.
Furthermore the payments in yuan between China and the USA, which is still China’s largest trading partner – account for 5% only, while Japan – the second largest country by volume of transactions with China – already operates 25% of its transactions with the yuan-renmimbi.
Only South Korea – another primary commercial point of reference for China – does use the Chinese currency for a very significant 86% of bilateral transactions.
Certainly the oil market remains essential for the creation of petroyuan or, in any case, for the globalization of the Chinese currency.
Since 2017 China has overtaken the USA as the world’s largest oil and gas importer.
Furthermore, as early as 2009, the Chinese authorities have criticized the use of the US currency alone as a basis for international trade.
In fact, the Chinese political leadership would like to define a monetary benchmark among the main currencies and later build the progressive de-dollarization of trade on it.
Obviously the expansion in the use of the Chinese currency in global transactions, which peaked in 2015, corresponded to the phase when the yuan was undervalued and gradually and slowly appreciated as against the US dollar.
After the two devaluations of the yuan-renmimbi in the summer of 2015, the profitability of replacing the US dollar with the Chinese currency has clearly diminished.
Moreover, since the possession of the yuan is still subject to restrictions and checks, the globalization of the Chinese currency cannot fail to pass through the full liberalization of China’s currency and financial markets.
A project often mentioned by President Xi Jinping and implemented by the Central Bank, especially with maximum transparency on transactions and the end of the capital “shares”, in addition to the quick acceptance of a price-based financial system.
Moreover, all the currencies with which China trades in the oil markets are still pegged to the US dollar and, for the Chinese authorities, this is another difficulty to replace the US currency.
On the domestic side, the yuan has a big problem: it is a matter of investing Chinese savings, which are currently equal to 43% of GDP.
If we consider a similar investment rate, the Chinese economy is no longer sustainable.
Therefore, either all investment abroad is liberalized – but, for China, this would mean the loss of control over domestic savings – or the yuan becomes a new international currency, thus using it for long-term loans in the Belt and Road Initiative and for creating a market of yuan-denominated oil futures.
Hence, unlike petrodollars, the petroyuan is not a US internal way to use the Arab capital stemming from the energy market, but a large internal reserve of capital to meet the needs of an expanding economy and support China’s fresh capital domestic requirements.
For Swiss banks, however, the flow of renmimbi-denominated contracts will radically change the energy financial market, but in the long run, thus obliging many global investors to invest many resources only in the Chinese financial market.
It is worth reiterating, however, that the Chinese currency has not fully been liberalized yet – nor, we imagine, will it be quickly liberalized in the future.
In essence, China wants to govern its development and it does not at all want to favour the US single pole.
Hence either a small monetary globalization, like the current one, or the large and progressive replacement of the dollar with the renmimbi – but this presupposes the liberalization of the entire financial market denominated in the Chinese currency.
Moreover – but this would be fine for the Chinese government – foreign and domestic investors’ full access to the Chinese capital market should be granted.
It already happened in 2017 but, nowadays, it becomes vital for the geopolitical and financial choices made by President Xi Jinping’s China.
Hence, it is likely that in the future China would play the game that Kissinger invented after the Yom Kippur War, i.e. the game of the dollar surplus in the Arab world that is reinvested in the US market.
Obviously, this has kept the US interest rate unreasonably low with an unreasonably high US trade surplus.
A monetary manipulation made using one’s own strategic and military leverage.
Hence, with petrodollars, the USA has invented the monetary perpetual motion.
Therefore, if most of the Chinese oil market is denominated in yuan-renmimbi, a strong international demand for Chinese goods and services will be created or there will be a huge amount of capital to invest in the Chinese financial markets.
This will obviously change the role and significance of China’s engagement in the world.
With significant effects for the dollar market, which could be regionalized, thus highlighting the asymmetries which currently petrodollars hide: the US super-trade surplus and the simultaneous very low interest rate.
What about the Euro? The single European currency has no real market and it shall be radically changed or become a unit of account among new infra-European currencies.
GIANCARLO ELIA VALORI
Honorable de l’Académie des Sciences de l’Institut de France