The Petro-Yuan, One Belt One Road, and Chinese Economic Grand Strategy

In the global financial balance of power, China is on a collision course with the United States. Unlike the U.S.’s rapid ascension following World Wars I and II, China has taken a slow and methodical approach to surpass U.S. economic influence, mainly through subverting the dollar and creating trade links through the One Belt One Road initiative.

The Chinese 30-year plan, with the ultimate goal of becoming a “global leader in terms of composite national strength and international influence,” demands that it challenge nearly a century of U.S. dominance. The question remains, will they choose to play within the western dominated global order or against it? Their deeds indicate the latter. The introduction of the petro-yuan, the One Belt One Road initiative, and smaller projects such as the recent peso-yuan trading facility are clear attempts to de-dollarize global trade and increase China’s economic sphere of influence.

The Petro-Yuan

In 1974, President Nixon made an agreement with the Kingdom of Saudi Arabia to price all oil transactions in U.S. dollars in exchange for military protection. This meant that every country in the world now required an enormous amount of dollar reserves in order to settle oil transactions. With the collapse of the Bretton Woods dollar exchange mechanism three years prior, this kept foreign countries from reducing their dollar reserves.

In March 2017, China introduced a yuan denominated oil futures contract. On the one hand, China constitutes 18% of global GDP with only 1.6% of SWIFT global settlements conducted in yuan. Combine this with the fact that China is the largest global net importer of oil and it makes sense that China would want to conduct these transactions in their own currency. One the other hand, China’s destabilization of the petrodollar system will undoubtedly not sit well with the United States, especially considering that it provides an alternative to countries normally considered antagonistic towards the west. 

While hovering between the 2-6% of total WTI volume in March and April, yuan denominated oil contracts skyrocketed to 14% of total volume by early May. This is significant for two reasons. Firstly, it is a major step in the internationalization of the yuan and ultimately weakens the status of the dollar as the global reserve currency. Second, it contributes to the creation of western and anti-western trading blocs. China has thus far made agreements with Russia and Angola to purchase oil in yuan. Iran, using yuan denominated oil futures as a way to circumvent U.S. sanctions, has already switched over to the petro-yuan and Venezuela is expected to follow suit.

Peso-Yuan Trading Facility

The recently created peso-yuan trading facility is another underreported story with far reaching consequences. On October 31 of this year, China and the Philippines agreed to create a trading facility that allows direct conversion between the Philippine peso and the yuan for transactions between the two countries. Before this agreement, the countries had to convert their currencies into dollars. Eliminating this one step grants the Philippines greater access to the Chinese bond market and grants Chinese banks greater reach in Asian markets.

Both countries are already taking advantage of the trading facility. The Philippines agreed to a $200 million “panda bond” offering (government bond denominated in Chinese RMB), and the Export-Import Bank of China agreed to finance two major infrastructure projects in the Philippines. The first step in de-dollarization of global trade is regional hegemony through closer economic ties and the de-dollarization of Asian trade. As the One Belt One Road (OBOR) initiative indicates, this goal is well under way.

One Belt One Road

OBOR, also referred to as the Silk Road Economic Belt, is a Chinese infrastructure initiative that seeks to create trade routes between 66 countries in Central Asia, the Middle East, and Europe. The project will affect 4.4 billion people and roughly one-third of global GDP. 

Not only does OBOR have the potential to solidify trade ties between China and rest of the eastern world, but it creates financial interdependence through the vast lending network that has occurred to finance the project. Among the greatest borrowers from Chinese banks include Kuwait, Lebanon, Sri Lanka, Armenia, and Malaysia, each borrowing 21.05, 7.37, 7.57, 4.71, and 3.15% of GDP respectively in order to finance infrastructure projects. While some praise the prospects of OBOR to pull under-developed countries out of poverty, the lending project has many predatory or tributary aspects to it. 

For example, Sri Lanka created the Mattala Rajapaksa International Airport (MRIA) with $190 million worth of Chinese loans and the Hambantota deep sea port with $310 million. As Sri Lanka became unable to finance the loans with revenue gained from the projects, China seized control of the deep sea port while India gained ownership of the insolvent airport. Today, Sri Lanka has a national debt of $64.9 billion, with $8 billion owed to China it will likely never be able to repay.

Conclusion

Observe China’s actions in the economic realm for the past decade and their grand strategy becomes clear. 1) Create regional trade ties and economic interdependence through OBOR. 2) Internationalize the yuan through commodities trade. It began with the petro-yuan in March, 2018, which has shockingly gained 14% of total WTI volume in less than a year of existence. With the London Metal Exchange seeking to launch yuan-denominated futures in the near future, this trend shows no signs of slowing down. This trend creates downward pressure on the dollar as the yuan increases its percentage in global SWIFT payments. However, and more importantly, the creation of western (dollar based) and anti-western (yuan based) trading blocs has vast geopolitical implications.

China has its fair share of economic issues that may prevent its far-reaching goals from coming to fruition. However, with these trends in motion, the lethal combination of the Petro-yuan and OBOR in its attempt to dethrone the dollar as the global reserve currency may be the most important story of the 21^st century.