Nick’s Note: One of our goals at the Daily is to help you build a strong portfolio. Usually, that’s by adding quality assets like income-producing stocks or asymmetric trades like cryptocurrencies. But sound investing also means weatherproofing your portfolio from potential crises.
Today, I’m sharing an essay from colleague and Crisis Investing editor Nick Giambruno. Nick says China is working to displace the U.S. dollar as the world’s leading reserve currency. Below, he explains why you need to prepare for this possibility.
By Nick Giambruno, editor, Crisis Investing
Ron Paul told me this would happen…
Dr. Paul first laid out his theory in 2006, in a little-known speech, during an otherwise dull session of Congress. I think it’s his most important speech ever.
During the speech, Paul traced the history of the U.S. dollar within the international financial system.
Crucially, he pointed out the one thing that would precipitate the U.S. dollar’s collapse. Now that one thing is about to happen.
Here’s the most important part (emphasis mine):
The economic law that honest exchange demands only things of real value as currency cannot be repealed. The chaos that one day will ensue from our 35-year experiment with worldwide fiat money will require a return to money of real value. We will know that day is approaching when oil-producing countries demand gold, or its equivalent, for their oil rather than dollars or euros. The sooner the better.
In other words, we’ll know the dollar-centric monetary system is about to end when countries start trading oil for gold or its equivalent… not dollars.
Now—thanks to China—that’s about to happen in a very big way.
Nick Giambruno and Ron Paul
(I discussed all of this with Ron Paul extensively at a past Casey Research conference. He told me he stands by his assessment.)
China recently announced a mechanism that will make it possible to trade oil for gold on a large scale for the first time in many decades.
This mechanism could undermine the petrodollar system—the system that’s supported the U.S. dollar as the top global currency since the 1970s.
I call it China’s “Golden Alternative” to the petrodollar.
The petrodollar system is the reason foreign countries keep such large U.S. dollar reserves.
Now China is set to hit the petrodollar with a mortal blow…
China’s Golden Alternative to the Petrodollar
Throughout history, every great power has had money that’s recognized around the world. Usually, these currencies have been tied to gold and silver.
Ancient Greece had the silver drachma. Rome had the silver denarius. The Islamic Caliphates had the gold dinar and the silver dirham. Venice had the gold ducat. Great Britain had the gold sovereign.
The United States used silver in its coins until 1964. And the dollar was under a pseudo-gold standard until 1971.
Now it’s China’s turn.
It’s no secret that China has been stashing away as much gold as it can.
Today, China is the world’s largest producer and buyer of gold. According to informed observers, China now has official reserves of over 160 million ounces. It also has 400 million ounces in the ground that it could potentially mine.
(The U.S., by contrast, claims it has official reserves of around 260 million ounces.)
China’s Golden Alternative is the reason it’s been stashing so much gold.
The Golden Alternative will allow anyone in the world to trade oil for gold. It will totally bypass the U.S. dollar and the U.S. financial system.
For many, it will be much more attractive than the petrodollar system.
The Golden Alternative is the beginning of the end of the international monetary system that has reigned since the early 1970s.
Here’s how it will work…
The Shanghai International Energy Exchange (INE) is about to launch a crude oil futures contract denominated in Chinese yuan. It will allow oil producers to sell their oil for yuan.
Of course, most oil producers don’t want a large reserve of yuan. China knows this.
That’s why China has explicitly linked the crude futures contract with the ability to convert yuan into physical gold through gold exchanges in Shanghai (the world’s largest physical gold market) and Hong Kong. The system won’t touch China’s official gold reserves.
Oil producers will have two ways to do this:
Immediately convert the yuan they receive from selling oil into physical gold at the spot price for immediate delivery.
Or, lock in the gold to be delivered at a future date for a fixed yuan price with a gold futures contract. This eliminates any uncertainty because of fluctuating prices.
Bottom line, it will allow oil producers to sell oil for gold. Producers will be able to completely bypass the petrodollar system and any restrictions/regulations/sanctions of the U.S. financial system.
I recently spoke with the officials at the exchange. They told me they plan to go live with the INE crude contract before the end of the year.
China Wants Pricing Power
One of China’s key goals here is to reduce the dollar’s influence over oil pricing.
China is the world’s largest oil importer. Developing the new crude contract gives it some global pricing power.
Currently, most of the $1.7 trillion worth of oil traded each year is priced off of two U.S. dollar-denominated crude benchmarks: West Texas Intermediate (WTI) and Brent.
Beijing thinks the yuan crude contract will reflect the market conditions in Asia better. It could become the most important oil benchmark in Asia.
The vice-chairman of the China Securities Regulatory Commission recently said:
The country will make crude oil futures the new starting point of opening up all futures markets…
And then, we will allow foreign players, whose enthusiasm is very high at present, to enter other futures markets, such as iron ore and PTA, when conditions are ripe.
In other words, oil is just the beginning.
Eventually, China plans to challenge the dollar’s dominance over all commodities.
PetroChina and Sinopec, two giant Chinese oil companies, will provide liquidity to the new yuan crude futures.
But non-Chinese companies will be welcome, too. The crude yuan future will be China’s first commodities futures contract open to foreign investors.
JPMorgan and UBS have already gained approval to trade. So have over 6,000 individual traders. It’s just a matter of time before the other big global players join.
Remember the big idea here… the new yuan crude futures contracts will be a huge hit to the petrodollar.
And it’s going to make a lot of money flood into gold—money that would have otherwise gone into the U.S. dollar and U.S. Treasuries.
“We Don’t Have a Country”
The breakdown of the petrodollar will cause a financial crisis.
Here’s how things will unravel…
The petrodollar system is one of the most powerful forces driving the U.S. bond market. Oil-producing countries accumulate hundreds of billions of U.S. dollars in oil profits, which they recycle back into U.S. Treasuries.
This keeps interest rates lower than they would be otherwise. It allows the U.S. government to finance enormous deficits with debt at an artificially low cost.
If the petrodollar system unravels, interest rates will soar. (Interest rates are currently near historic lows.)
Even a small rate increase is a lethal threat to the US budget.
The U.S. government currently needs over $400 billion from taxpayers just to pay the interest on its debt. Tax receipts are just over $2 trillion.
If interest rates rise…
1%, the government would need over $600 billion to pay the interest on its debt.
2%, it would need over $800 billion.
3%, it would need $1 trillion.
4%, it would need over $1.2 trillion, or over half of what it currently snatches from taxpayers—again, just to pay the interest.
Clearly, none of this is sustainable.
Trump was correct last year when he noted: “What happens if that interest rate goes up 2, 3, 4 points? We don’t have a country.”
In many ways, this could turn into President Trump’s financial 9/11.
The petrodollar system has allowed the U.S. government and many Americans to live way beyond their means for decades.
The U.S. takes this unique position for granted. But it will disappear once the petrodollar system breaks down.
When that happens, inflation could be severe.
This will likely be the tipping point…
Afterward, the U.S. government will be desperate enough to implement capital controls, people controls, nationalization of retirement savings, and other forms of wealth confiscation.
I urge you to prepare for the economic and sociopolitical fallout while you still can. Expect bigger government, less freedom, shrinking prosperity… and possibly worse.
It’s probably not going to happen tomorrow. But it’s clear where this trend is headed.
It is very possible that one day soon, Americans will wake up to a new reality.
Until next time,
Editor, Crisis Investing
P.S. I started to see the pieces falling into place late last year. That’s why I told readers the death of the petrodollar would be the No. 1 black swan event of 2017.
Eventually, I think people will look back and see China’s Golden Alternative as the catalyst that made it happen. We recently released a video that shows how it could all go down… Click here to watch it now.
He’s just an ordinary guy born on a farm in Kansas. He didn’t graduate from a fancy college. He doesn’t have an MBA.
Yet he stumbled upon a “secret key” technique that allowed him to retire at 42… and still make more money in 8 hours… than most people make in a month.
But Monday through Friday you’ll find him up by 4 a.m., in front of his computer… using his “secret key” to generate thousands of dollars per week… without touching stocks or bonds. He calls it his retirement hobby.