Posted by on November 7, 2017 3:40 am
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Categories: barack obama Business Central Banks China Crude Crude Oil Currency dollar East Asia Economy Finance fixed Foreign Central Banks Foreign exchange market Gold standard Henry Kissinger International trade Iran Iraq japan Jim Rickards Middle East Monetary hegemony money north korea Nuclear Power Politics Renminbi Reserve Currency Saudi Arabia The Economist U.S. Treasury United States dollar Yuan

Authored by Bryan McBride via Mises Canada,

Is Korea just a smokescreen?

In my last article (Sticking the arson charge on a couple of patsies) I questioned why North Korea’s nuclear program was attracting such attention from the United States. North Korea is a very poor and backwards country whose bellicosity reflects the regime’s need for an external enemy like the United States to galvanize domestic support. Attacking America and its allies in the region is the last thing North Korea’s leaders would want to do as such an attack would guarantee an American response that would be sure to destroy their lives, their government and the lives of millions of innocent Korean civilians.

However, this month I was made aware of another possible reason for the attention being paid to North Korea and its nuclear program.

What if the escalating tensions over Korea are just a smokescreen intended to legitimize an American military buildup in the region aimed at intimidating China?

In 2011, former U.S. President Barack Obama announced a change in U.S. foreign policy that was termed a ‘Pivot to Asia.’ The official thinking was that as China and the emerging countries of South-East Asia gained in economic importance, it made sense to devote more military and diplomatic attention to the region while reducing the attention paid to Europe and the Middle East.

Of course, observers also saw the pivot as a response to the rising economic, political and military power of a resurgent China. Just as the U.S. sought to contain the Soviet Union during the Cold War with a string of encircling alliances and economic agreements, so America today seeks to keep China in check through military alliances with East Asian countries like Japan, South Korea and Taiwan and trade agreements such as the Trans-Pacific Partnership (TPP).

Chinese leaders acutely resent continued American dominance in a region they consider their own backyard. However, they are not reckless and do not seek to engage in a potentially catastrophic military confrontation. Instead, they have spent the past few years establishing institutions and agreements which, taken together, will displace the U.S. dollar from the centre of the global financial system. Empire is expensive. Just as the British were forced to decolonize in the 1960s once the pound lost its reserve currency status in the years following World War II, so too will the demise of the dollar force American retreat from global (and, most importantly for the Chinese, East Asian) hegemony.

At this point, it is worthwhile to recall how the U.S. dollar became (and remains) the world’s reserve currency in the first place. At the Bretton Woods conference in 1944, it was agreed that all currencies would have a fixed exchange rate with the U.S. dollar, which itself would have a fixed value in terms of gold. From 1945 until 1971, foreign central banks were allowed to exchange their accumulated dollars for gold at a price of $35/ounce. As the U.S. dollar was literally ‘as good as gold,’ commodities were priced in dollars and foreign governments found it desirable to accumulate and hold dollars in order to purchase imports.

However, by the late 1960s the system was coming under stress. The value of the U.S. dollars in circulation abroad was far greater than the value of the 8000 tons of gold held by the U.S. Treasury in Fort Knox, Kentucky. In order to stop foreign governments stripping the U.S. of its gold reserves, in 1971 U.S. President Richard Nixon ‘temporarily suspended’ the convertibility of dollars for gold. Predictably, while a dollar bought 1/35th of an ounce of gold in 1971, by 1980 it only bought 1/850th of an ounce.

To try to arrest the decline in the value of the U.S. dollar Richard Nixon, in one of the last acts of his presidency, sent newly-appointed Treasury Secretary William Simon to Saudi Arabia in 1974. The agreement he came away with reinforced the dollar’s position as the global reserve currency by replacing gold convertibility with oil convertibility. In exchange for agreeing to price and sell oil in dollars and to lend their newly-acquired oil wealth to the U.S. by purchasing U.S. government Treasury bonds, the U.S. agreed to provide military aid and equipment to the Saudis.

To this day, oil continues to be priced and sold in dollars. As everyone therefore needs U.S. dollars (often referred to as petro-dollars) in order to purchase crucial energy imports, the dollar has remained the world’s reserve currency.

However, China has recently established two complementary markets aimed at removing this crucial pillar of dollar support. First, in April 2016 the Shanghai Gold Exchange launched a yuan-denominated gold price fix in order to become a price maker in a market historically dominated by London and New York. Uniquely, though, while in London and New York traders deal mainly in paper contracts for gold which are very rarely exercised, the Shanghai market is primarily a spot market whose participants purchase physical gold, usually in the form of one kilogram bars.

Second, within the last two months China has announced its intention to offer a crude oil futures contract denominated in yuan before the end of the year. This contract will establish a benchmark price for oil in yuan to compete with the dollar-denominated oil prices set in New York. To make the yuan-denominated contracts more attractive to oil exporters, the Chinese are emphasizing the convertibility of yuan for gold at the Shanghai Gold Exchange. As the economist and lawyer Jim Rickards put it recently:

“China, Russia and Iran are coordinating a new international monetary order that does not involve U.S. dollars. It has several parts, which together spell dollar doom. The first part is that China will buy oil from Russia and Iran in exchange for yuan.


“The yuan is not a major reserve currency, so it’s not an especially attractive asset for Russia or Iran to hold. China solves that problem by offering to convert yuan into gold on a spot basis on the Shanghai Gold Exchange.


“This marks the beginning of the end of the petro-dollar system that Henry Kissinger worked out with Saudi Arabia in 1974, after Nixon abandoned gold.”

Chinese yuan with the gold-convertibility of the pre-1971 U.S. dollar should prove an attractive alternative to the dollar for major oil exporters. Just this past month Saudi Arabia, the country at the centre of the petro-dollar arrangement, agreed to purchase S-400 air defense missile systems from Russia. By making this purchase, the Saudis are signaling that they no longer feel obliged to rely on America for their arms as laid out in the 1974 petro-dollar agreement. Might this historic first signal a repudiation of their commitment to price their oil in dollars as well?

If so, the end of the dollar is at hand, and with it the beginning of the end of the American empire. Weaker countries like Iraq and Libya which tried to price their oil exports in, respectively, euros and gold-backed dinars were invaded and bombed by the U.S. in order to maintain dollar supremacy. Given this history, the threat to American power posed by a yuan-denominated global oil market may also be met with force.

This being the case, it is reasonable to question whether the American air and naval units being moved to Asia are in fact being sent to protect American allies from North Korean missiles.

Looking at the bigger picture, it seems more likely that the entire Korean issue is a smokescreen designed to provide cover for a military buildup intended to intimidate or even force China to abandon its challenge to the U.S. dollar. However, China is not Iraq or Libya. It is a major nuclear power. Trying to enforce continued dollar dominance in East Asia could very well end in catastrophe for America, East Asia and the entire world.

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