Thread by @arbedout

A thread on the Shanghai INE crude oil futures, what they represent, what everyone is missing, and why I think they're worth paying attention to.

Let's do this. (Thread 1 of 2!)

First, some background: in late 2013 Xi Jiping announced the 'One Belt, One Road' initiative, which might best be described as a Chinese Marshall Plan. By May 2017, the OBOR began to transition from vague dream to tangible reality. A quick explainer:

qz.com/983460/obor-an…

Part of the OBOR initiative involves the creation of the AIIB, Asian Infrastructure Investment Bank - the Chinese answer to the World Bank - and the Silk Road Fund, the Chinese answer to the International Monetary Fund.

As of today the AIIB has $100B of capital (~50% of the World Bank). The United States is less than thrilled about this state of affairs.

In October of 2016 the IMF announced that they would be adding the yuan to their reserves as one of the currencies that backs the SDR. This was the first update to the basket of reserve currencies in nearly two decades.
bloomberg.com/news/articles/…

In July 2017, the ECB announced they've shifted a small amount of their holdings from dollars to yuan. This was a) pretty unremarkable and b) also would have been wildly unthinkable circa 2007 (IMHO, I should say.)

news.cgtn.com/news/3d45444f3…

Other European central banks followed, and finally six months later, in January of 2018, the Bundesbank announced that they were decreasing
their holdings of US dollars and increasing their holdings of yuan.
bloomberg.com/news/articles/…

In May of 2018, 14 African nations held a meeting to discuss the use of the yuan as a reserve currency:

qz.com/africa/1291372…

And just yesterday, Nigeria - one of the countries in that May MEMFI meeting - began to offer yuan for sale to local
traders and banks, as an apparent dollar alternative.

qz.com/africa/1346766…

So what does this have to do with the Shanghai INE futures contracts? I'm getting there.

Recall that in December of 2017, after several false starts, Chinese regulators announced that crude oil futures contracts would be
launching in Spring of 2018.

reuters.com/article/china-…

Despite some initial skepticism, it seems that the contract is attracting enough interest to at least not be an abject failure.

https://twitter.com/Ole_S_Hansen/status/1021363386817433600

Crude futures are the first step to a potential 'petroyuan' - which to be absolutely clear, does not exist today.

To understand what a petroyuan would look like, we first need to understand what a petrodollar is.

The post Bretton Woods monetary system of free floating currencies doesn't have any explicit guarantees that a particular currency should serve as a global reserve. The dollar is a de facto global reserve currency, not de jure.

One reason the dollar has played such a prominent role in the global monetary system is down to the fact that central banks really like to hold dollars (compared to, say, Turkish Lira).

It's true that part of this preference is because the US is a great place to invest and store your money, at least compared to other countries. But that's not the whole story. American hegemony - both financially (the carrot) and militarily (the stick) are part of the equation.

Any nation could theoretically try to force other to use their currency as a reserve at gunpoint, but it's comparatively much easier to just make sure that everyone wants and needs your currency.

(Forcing people to use your currency at gunpoint really only works domestically).

You might be able to do this by offering a more private environment to store your wealth than other countries (see the Swiss CHF), or better investment opportunities and looser capital controls (as found in the US)....

....but if your primary goal is just to maintain demand, it turns out the easiest way to ensure your currency is in higher demand than any others is by, umn, let's say "convincing" a petro-rentier state to price their oil exports in your currency.

Every country in the modern world wants and needs petroleum products, so they're all going to need to get their hands on your currency to pay for it, either by exchanging goods for your currency or taking out loans denominated in it (e.g. through the IMF and World Bank).

That's the basic idea behind the petrodollar, and it provides some insight into America's weird relationship with the Middle East in general and Iran, Iraq and Saudi Arabia in particular (given the share each has of the world's petroleum exports).

Back in the early 1970s, after Nixon closed the gold window and the oil embargo sent prices skyrocketing, an understanding was reached between the United States and certain OPEC countries to ensure that petroleum exports were priced exclusively in dollars.

Depending on who you talk to, this was either a totally above-board and normal agreement between equal partners - world's largest buyer and world's
largest seller negotiating terms - or a conspiracy between the Bilderberg Group, the Seven Sisters, and Colonel Sanders.

So! That's the petrodollar, in theory. Now. To understand why crude futures are the first step to a petroyuan: in order for commodity producers to hedge against counterparty risk and currency risk, there needs to be someone willing to "take the other side of the trade"...

...or more plainly, in order for oil producers to be willing to deliver their commodity to you priced in your currency, they need to be able to lock in a guaranteed future price for delivery of their commodity, and to have someone else take on the risk.

The futures contract is not the petroyuan; rather, a strong, liquid futures market for oil priced in yuan is a necessity for any oil producers to consider delivering oil priced in yuan.

(Stay tuned for the second part of this thread, I've hit the limit on # of tweets allowed 😯)

Thread continued here:

https://twitter.com/arbedout/status/1025401094862778369