June 7, 2024
The background
There is little doubt in both Russian and Chinese government circles that the dollar is not only declining but could now face an existential crisis. The decline is coming about fuelled by China and Russia progressing with plans to reduce the use of the dollar, not just between themselves but throughout their spheres of influence. Courtesy of the USA, it is no longer being used between China and Russia, a move which has focused minds elsewhere about the US's weaponisation of its currency.
The weaponisation of the dollar has removed any complacency in China's approach to the dollar problem. She is now in no doubt that the dollar must be removed from her trading interests as much as possible and as a matter of urgency. This is behind the PBOC's selling of dollars for gold. The PBOC knows that by dumping dollars, she threatens the entire western fiat currency system. But with the US becoming increasingly belligerent towards China they also know that there is little alternative.
Furthermore, after a prolonged period of heavily suppressed US interest rates and budget deficits running out of control, the US's debt trap driving is bond yields higher and threatens to collapse the entire dollar-based credit system. Managing the fallout must be the hottest of topics between China and Russia, and the future for trade settlements between the Shanghai Cooperation Organisation and BRICS+. Along with these two organisations, both Asian hegemons also know that they must make themselves independent of the dollar for fear of being caught in its downdraft.
China and Russia have already made significant progress in this direction, having put their own intra-national trade on a rouble-yuan basis, with China acting as a conduit for Russia's exports to other importers as well. As long ago as 2015, China launched her Shanghai-based CIPS (cross-border payments system), allowing banks to clear cross-border renminbi transactions onshore, instead of offshore settlements using SWIFT or New York clearing. Besides trading in gold and silver futures on the international section of the SGE, China has also established trading platforms pricing in renminbi for other key commodities: oil and copper futures in Shanghai, and on the Ganzhou Rare Metal Exchange spot prices for cobalt, tungsten, and a number of rare earth metals.
But what interests us here is not so much commodity pricing but cross border trading settlements between China, Russia, other members of the SCO, BRICS+, and any other trading partners in the expanding "global south". The solution proposed by Russia last year was to establish a gold-backed trade settlement currency which failed to make the Johannesburg agenda last August. India's Keynesian leadership didn't like it, and China was cautious, preferring not to rock the dollar boat. However, India is now accumulating gold and has sought the repatriation of 100 tonnes from the Bank of England, indicating that she now accepts that gold is the final solution, and that it may not be long in coming.
Other Asian central banks are similarly beefing up their gold reserves, as are the East Europeans, particularly Poland. The signal emanating from well-informed Singapore's aggressive accumulation is important confirmation. The common story is that China and Russia are prepared to move to a gold standard, when circumstances dictate. We know that Russia has substantial reserves, perhaps as much as 12,000 tonnes including holdings in two sovereign wealth funds and she is beefing up her mine output. China has been secretly accumulating gold off-balance sheet since 1983, became the largest gold mining nation by output over a decade ago, and she is like a Hotel California with respect to bullion imports from other nations. I believe various Chinese state accounts now hold a hidden total of over 30,000 tonnes. And we know that deliveries from the Shanghai Gold Exchange to the general public already total nearly 26,000 tonnes, not to mention the significant holdings by commercial banks on behalf of customer gold accounts retained within the SGE's vaulting system.
Clearly, China has expected and planned for the end of the dollar as a reserve currency for a considerable time, and it is therefore imperative that her international trade be made independent of its collapse. Eventually, only gold backing for SCO and BRICS+ currencies will replace the dollar, because the death of the dollar will mean the end of the entire western fiat currency system, which is why every country in Asia is ensuring they have gold reserves. But until that time there must be interim arrangements.
The SCO and BRICS have agreed to accept each other's currencies in trade settlement. On the face of it, it exposes nations with strong currencies to payment risk in weak currencies. China deals with the problem by trying to ensure that net exposure is minimised by balancing imports with her exports plus capital investment. But this cannot work for everyone, particularly oil exporters to other SCO/BRICS members.
There are three solutions to the problem. The first is for an exporter to accept a non-dollar foreign currency in trade settlement. This is already the case with respect to oil exports from the Saudis to China, replacing petrodollars with petroyuan. The second is to accept a generally unmarketable currency, such as Kenya shillings, with a guaranteed swap rate locking into today's exchange rate until the currency can be disposed and the difference settled between nations. But this requires faith in an issuing central bank to discharge future obligations and has limited practicality. The third solution is to use a third party's currency as replacement for the dollar in this role: it can only be China's renminbi, with the rouble perhaps in the Eurasian Economic Area.
The use of renminbi for trade settlements is bound to spread, because with China's CIPS system at their heart the only use the dollar will have is for the pricing and acquisition of commodities and raw materials sourced globally. Perhaps more quickly than generally realised we will see the renminbi becoming the reserve currency for rapidly industrialising nations with most of the world's population.
With foreigners holding dollars and financial assets currently estimated by the US Treasury to be over $32 trillion, a significant portion is held by China and together with Russia and their trade linked counterparties. China has already started to liquidate her dollars, and we can be certain that others will follow. The timing of dollar repatriation could not come at a worse time for the US, because she has become heavily reliant on foreign demand for dollars and their investment in US Treasuries. This source of credit is turning from being dollar buyers to sellers.
At the same time, US Government budget deficits continue to increase, partly fuelled by politicians seemingly unaware of their debt trap, and also by higher debt funding costs, which are being compounded into yet more debt. Consequently, with budget deficits still rising, the dollar's purchasing power continues to be diluted, which will drive consumer price inflation and therefore bond yields into a new rising trend. It is the unhappy combination of these events which is set to collapse the dollar along with the western currencies associated with it.
While domestic Americans may have difficulty seeing this logic, we can be sure that China, Russia, and their trade cohorts are fully aware of the consequences. The problem for China is twofold: to be fully prepared for the end of the dollar, and to not be associated with the dollar's destruction. This destruction is unlikely to be reflected in its exchange rate with other currencies, but in commodity, food, and raw material values, broadly represented by gold.
As noted above, China and Russia have substantial undeclared gold stocks which in the future will be the basis for renminbi and roubles issued to acquire all materials. It will require both the renminbi and the rouble to be valued as gold substitutes, not as fiat currencies likely to sink with the dollar. It is becoming clear that the renminbi will be the reserve currency replacement for nations representing the large majority of the world's population, and that as a second step its value will be secured by a credible link with gold, making it a gold substitute.
That the pace of this evolution is hotting up can be judged by the speed of the PBOC's selling of US Treasuries, and that China is stockpiling copper in quantities which appear to be greater than her prospective consumption. Furthermore, the dollar's future, and euro's as well, depends in large measure on events in Ukraine. NATO is escalating tensions threatening to become more directly involved. This attack on Asian territory could force Russia to declare a gold standard for the rouble, not just to protect it but to undermine the fiat currency-based credit structure upon which the western belligerents depend.
If Russia does take this step, we can be sure that it will be in consultation with China and that China will rapidly follow, putting the renminbi on a gold standard as well. As they say in chess, we are now in the endgame for the dollar-based financial system and checkmate will come in just a few moves.
Reprinted with permission from MacleodFinance Substack.