By Sara Hsu
April 07, 2018 "Information Clearing House" - In a challenge to longstanding American dominance of the oil industry, China is reportedly planning to launch a pilot program to pay for oil in its own RMB, potentially starting in the second half of this year. Regulators have asked several financial institutions to prepare to price oil imports in RMB. Two of China’s top suppliers, Russia and Angola, may be asked to trade in RMB, and China recently began trading oil futures in its own currency.
China surpassed the U.S. as top oil importer last year, importing 8.4 million barrels per day versus U.S. imports of 7.9 barrels per day. Due to its status as a major market for crude oil, China launched RMB crude futures on March 26. The new futures market received a warm welcome, with a 20 million barrel turnover by the market close on the first day. What does this mean, then, for China’s potential to use the RMB in oil import payments, and will this mark the beginning of the end for dollar dominance in the oil trade?
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Potential of using RMB payments
Some say yes, some say no. There is some demand for an end to the U.S. monopoly over the oil trade. Countries like Russia and Angola favor ending dollar dominance in the global oil industry, as this has helped the United States to maintain a global economic hegemony and exert its political and economic influence. Nations that wish to reduce exposure to U.S. political risk (including the politics of sanctions) may be eager to reduce the importance of the U.S. dollar in world trade in favor of stable alternative trading currencies. If a number of oil-rich nations take up China’s would-be RMB-denominated oil trade, the centrality of the dollar in the oil trade will be diminished.
However, other analysts have made the case that, due to restrictions on China’s capital account and the daily fixed level of the RMB, the potential for extensive commodities trading in RMB is less attractive than other options available to foreign investors. Another reason trading in RMB may be less desirable is because the government often intervenes in markets when instability is perceived. These factors have generated wariness among would-be foreign traders, who like to trade in liquid and predictable markets.
Will this end dollar dominance in oil trade?
Countries like China and Russia wish to reduce their dependence on the dollar, and this appears to be a strategic goal. Increased use of the RMB in oil trading settlements will likely challenge the supremacy of the dollar, but this will take time because the dollar is so entrenched around the world. The dollar is used not only for commodities trading, but also as a key marker in exchange rate regimes and as an essential reserve currency. This convention has been in use since the Bretton Woods meeting after World War II, when the rest of the world (outside of the U.S.) was coping with economic and monetary instability.
At present, the dollar comprises about 64% of world reserve currencies (with the next largest being the euro at 20%). One-third of global GDP is generated by countries that fix their currencies to the dollar and 85% of foreign exchange trading involves the U.S. dollar. By contrast, the RMB comprises about 1% of global reserves. Despite recent turmoil in the U.S. stock markets due to political volatility, the U.S. is still considered the strongest economy in the world. While that doesn’t mean that its hegemonic status will last forever, China will have to prove to the world that it is not only politically and economically strong, but that it is stable and profitable. When that time comes, China will be able to increase the role of the RMB in the oil trade.
Despite the forces against the RMB as a global currency, it does have the potential to replace the dollar in the oil trade over time. This may take decades, however, and is contingent on the economic decline of the U.S. and continued growth and liberalization in China. In that case, the RMB will be more widely used, and, specifically in the oil trade, may be used not only for Chinese imports of oil but for the oil trade amongst other nations that are interested in building up RMB reserves.
This time may never come, but, as a scholar of economic history, I see it as entirely possible. Undoubtedly, the U.K. could not have predicted that America would overtake it as global hegemon after World War II. That China has RMB internationalization as a long-term objective makes the rise of the yuan all the more plausible; it is in the crosshairs.
This article was originally published by "Forbes" -
The views and opinions expressed in this article are the author’s own and do not necessarily reflect those of Information Clearing House.
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