The great unplugging

Way back in 2012 (remember then?), a Danish policeman ordered some Cuban cigars from Germany.

It was a perfectly legal and above-board bank transaction, but the money he paid – roughly £16,500 – disappeared.

Why? The answer is simple, but it reveals a flaw at the heart of global finance which creates more pressure by the year: the US dollar.

The Danish man had paid for the cigars in USD, a currency more acceptable to the German than krone, and so the payment had been routed through a US bank. And so in the US, a continent removed from the original transaction, the US authorities froze the transaction on the basis that it violated the US trade embargo on Cuba.

Using the US dollar lost the Danish policeman his money (the US rejected his appeal), and probably his cigars as well, illustrating the power the US wields in issuing and controlling the world’s reserve currency.

The absurdity of a German and a Dane doing business somehow violating an American trade embargo is not lost on the rest of the world, who have since been working to avoid the dollar trap. Especially those entering a Cold War against the US (China) as we enter an era of “great power competition”.

China is the world’s largest oil importer, and so far has been paying for it mostly in dollars. This exposes it to the risk that the US will lock it out of the global dollar-based financial system, if it doesn’t keep in line with the US (like Iran).

China wants to “unplug” from the dollar-based system and pay for commodities with yuan instead. Now that China is “too big to ignore” in the commodities space, it looks like it is gradually getting its wish. The Shanghai oil futures contract (denominated in yuan) has seen much more volume than anticipated when it was launched last year.

China has also been buying up commodity producing assets in Africa to reduce foreign reliance. This will also allow it to sell these commodities for yuan, increasing foreign demand for its currency. And with demand for currency, comes demand for government bonds, so investors can “park” their currency and earn a return on it. This in turn will allow the Chinese government to issue such bonds and borrow in its own currency, rather than the dollar.

And it’s not just China. India is also working around the dollar, incentivising rupee payments for oil from Iran. From Reuters, emphasis mine:

India’s finance ministry has exempted rupee payments made to the National Iranian Oil Co (NIOC) for crude oil imports from a steep withholding tax, according to a government order reviewed by Reuters.

The exemption, put in place December 28 but backdated to November 5, will allow Indian refiners to settle about $1.5 billion of outstanding payments to NIOC. Those have been building up since Tehran was put under stringent U.S. sanctions in early November.

The two countries on Nov. 2 signed a bilateral agreement to settle oil trades through an Indian government-owned bank, UCO Bank, in the Indian currency, which is not freely traded on international markets.

The dollar’s share of global currency reserves is now at an almost five-year low. Should China get its way, that figure is set to get much lower. But the US won’t roll over and let that happen easily.

The Second Cold War will exhibit many differences to the first. Energy, currencies, supply chains and trade between the US and the Soviet Union were not anywhere near as tangled as they are now between the US and China.

But while history doesn’t repeat, it does rhyme. Yesterday, the Chinese became the first to land a spacecraft on the far side of the moon. A new space race is underway…

Have a great weekend!

Boaz Shoshan
Editor, Capital & Conflict

Category: Geopolitics

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