How Will The "Fracking" in Oil Production Affect Gold?

The process of “Fracking” in the production of oil is increasing global oil reserves by around 11%. More importantly, it has been a success in the U.S. but is yet to be used in Europe and Russia to the same extent. Nevertheless, this is expected to happen. The initial impact is that the world’s dependence on Middle Eastern oil is falling fast and the stranglehold OPEC has had on oil prices is weakening considerably. But how should this affect the gold price you may well ask?

To show how important a factor this is, we should look at how oil is paid for. The U.S. dollar is still the oil currency. Most nations that buy oil must sell their own currency for the U.S. dollar, and then use those dollars to buy oil. This is how the U.S. dollar became the sole global reserve currency.

But this is changing. You may reason that with the U.S. eventually exporting oil and not importing it, the Middle East oil producers, previously considered their “vital interest” will no longer be so. But this story is not about oil self-sufficiency, but about the use of the dollar itself. As the oil currency, any fall-off of the use of the dollar will have a direct impact on the power of the U.S. and the globe’s dependence on the dollar as its reserve currency.

As China has been rising it has made it clear that it wants to be independent of the U.S. and, eventually, the U.S. dollar. To this end China is not keen to keep using the U.S. dollar to get its oil in the future.

To this end it has been arranging swap agreements with a growing number of countries whereby they will accept payments in Yuan and buy goods from China in Yuan, thus cutting out the road through the U.S. dollar. The process has been going on for the last few years but is now becoming significant in the Yuan’s road to a global reserve currency. For this to happen fully, the Chinese Yuan must be a freely convertible currency. This may take quite a few more year still as the Chinese monetary system is developed. But it is coming! At the end of this year China will be announcing a significant widening in the convertibility of the Yuan, the critical part of the internationalization of their currency.

This will force the U.S. dollar to be part of a multi-currency global monetary system and will lose its status as the only currency in which global trade is conducted.

Oil producers will therefore find the Yuan an acceptable trading currency with which to buy oil.

With the falling dependency on the Middle Eastern oil in the developed world as “Fracking” takes hold, we see even the Middle Eastern nations on the West side of the Persian Gulf (including Saudi Arabia?) accepting the Yuan in payment as its dependence on the U.S. as a customer lessens. Its customer base is widening considerably as it is forced to find new ones, of which China is the foremost.

As the U.S. diminishes as a customer, its influence over the West side of the Persian Gulf nations will weaken too. These States will gradually turn to the U.S. solely for their government’s ongoing provision of the security of the ruling governments there, but as the sectarian conflict swallows the entire Arab world, the appetite for military involvement, we see, as weakening there. Religion is a far more demanding cause with little regard for political support if it is not fully committed.

A look at how the Chinese have made inroads into Iraqi oil production after all the support that the U.S. has given the country aptly demonstrates this.

And Gold…

This shift in the balance of power of the dollar to the Yuan and other Asian currencies is significant to the gold price as the strains on the monetary system will be heavy during the transition and establishment of the multi-currency system.  It’s the acceptance of other currencies in payment of oil that will be a key to the lessening power of the dollar. It is oil that gave the U.S. dollar its global strength and hegemony and allowed it to cut the link to gold as the backing behind the dollar. So any move away from that key role will hit the value of the dollar and diminish its global role. This will demand that gold will fill the confidence gap left in the wake of such a systemic change as it did prior to the close of the “gold window” by President Nixon in 1971.

But for gold, such a shift will demand that it fills part of the role that the dollar had in making global trade work. After all, U.S. dollar acceptance is an expression of confidence in the U.S.A. and its power over the globe.

The rise of China undermines that power. The paper monetary system is based solely on confidence in the key governments behind them. If this confidence is weakened or even has to be shared with other governments, the reduction of the presence of U.S. dollars in the world has to take place. The huge volume of dollars used in the world could happen because of this power.

Any fall-off in that power will lead to a fall-off in the level of confidence in that currency. A fall-off in confidence in the U.S. dollar will result in a fall-off in confidence in the monetary system itself. With a fall-off in the need for the U.S. dollar with which to buy oil will come a fall-off in the global use of the dollar.

•    It may be that one day the Chinese will expect the U.S. to pay for Chinese goods with the Yuan. Then the U.S. will have to sell the dollar to buy foreign currencies.

•    It could be that nations will buy the Yuan to pay for their oil and other goods too, as we see happening to a growing extent now.

There are a host of avenues where the use of the dollar will drop. With this has to come rising doubts about the monetary system itself. In a multi-currency system the absence of one currency upon which all others are dependent will severely weaken the system itself, with the focus turning to confidence in the nation, its economy and its balance of payments. This will bring a level of uncertainty not seen before in the U.S., but which was well known in Europe and Russia in the last century. It is this variability in the degrees of confidence, which nations can inspire, that will necessitate the use of gold to provide a ‘value anchor’ in the global monetary system, without which it will falter and perhaps buckle.

To emphasize the point, we ask, “Where will all those dollars, no longer needed go?”

Britain experienced the same as its empire shrank and sterling became just another currency. Britain had to impose exchange controls to protect its currency. This resulted, initially, in a discount on the pounds used for investments (the Dollar Premium) to stand at 30% to the pound used in commerce to protect itself.

It is clear that the road ahead is uncertain and the non-national beauty of gold both as an asset and cash, ‘in extremis’ will prove critical to global money!

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