China and Russia Trade Agreement: More than Meets the Eye

By: Dr_Jeff_Lewis

Direct trade between China and Russia may be less than $50 billion annually, but it's not the numbers that matter.  Under the new agreement, China and Russia have decided that they will use their own local currencies to settle bilateral trade.  Previously, both countries used the United States dollar as an intermediary for settling delivery payments. 

Two sides of the argument quickly settled on two issues: that the dollar would experience lower demand, or that the sum of $50 billion is largely irrelevant.  Both of those viewpoints are correct; neither China nor Russia need to hold US dollars for bilateral trade, and in the grand scheme of international trade, $50 billion is a very small sum.

Truthfully, the days of the dollar as an international medium of exchange are over, and they have been over for quite some time.  With the explosion in electronic trading and free floating exchange rates, importers and exports can, within a matter of minutes, effective neutralize any currency risk with a simple financial transaction.  Thus, settling contracts in dollars for liquidity and stability purposes is no longer a function of the US dollar.

Where the Dollar Reigns as King

There is one market where the dollar is critically important.  Following a 1970s agreement with Saudi Arabia, the US dollar was made to be the only currency in which oil could be bought and sold.  The agreement was perhaps the best victory for the dollar since the official breakdown of the gold standard in 1971, as it meant that countries and companies would have to hold dollars for the sole purpose of buying energy, and that the United States was the only country that could buy oil with printed dollars.  Countries wishing to inflate to buy oil would have to make their actions immediately known by selling off large amounts of currency in floating international markets for dollars. 

Chipping Away at the Dollar’s Value

China exports a variety of products to Russia, but Russia sends back only one: oil.  With an agreement in place to avoid the dollar, China will now settle oil contracts in Renminbi or Ruble, not dollars. 

In the days of quantitative easing and concerns over US debt, the dependence of the oil market on dollars was one of the few anchors the currency had left.  With China now agreeing to purchase directly in another currency, and having already made direct investments in energy companies at home and abroad, a wedge is clearly being driven between the oil market and the dollar.

At current prices, some $2.3 trillion of oil is consumed annually, most of which is bought and sold in dollars.  The fate of the US dollar's utility now rests in the hands of the Saudis and whether they can keep OPEC, an organization responsible for one-third of total output, to keep trading barrels for bucks.  If they can't, the long precipitous decline of the American dollar will end, and we will see instead an instantaneous decline in the importance of the dollar and its value – which is yet another reason to further invest in precious metals. 

By Dr. Jeff Lewis

Dr. Jeffrey Lewis, in addition to running a busy medical practice, is the editor of Silver-Coin-Investor.com and Hard-Money-Newsletter-Review.com

Copyright © 2010 Dr. Jeff Lewis- All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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