May. 13, 2015 11:04 AM ET
Summary
- China's central bank is buying huge quantities of gold.
- China wants the yuan to become a reserve currency, but does not want a "strong yuan".
- China wants the leverage to control all currency values, which requires control of the gold market.
On April 20, 2015, Bloomberg Intelligence estimated that The People's Bank of China tripled its holdings of gold bullion, since April 2009, to 3,510 metric tons. That means, more or less, the Chinese government has purchased virtually all of its domestic gold production over the last 6 years.
The estimate is based on trade data, domestic output and the figures published by the China Gold Association. That means that the Chinese government is the second largest gold-holder in the world, outmatched only by the USA, which claims an alleged hoard of 8,133.5 tons of the yellow metal.
Bloomberg speculates that China is buying gold because it intends to bolster the acceptability of the Chinese yuan in international commerce. The line of thinking is that large gold holdings make currencies more credible candidates for reserve currency status. Yet, a gold-backed currency is not likely to impress the staunchly anti-gold IMF, or increase the likelihood that the Chinese yuan will be added to SDR. Just the opposite.
The IMF was founded by western nations, and the nation with the largest number of voting shares is the United States. For historical reasons, most Western nations, and particularly the USA, continue to be anti-gold. During the 1920s, America gave lip-service to being on a so-called "gold standard".
However, in common with most western nations, it printed far more paper money than the gold reserves could back up.
When a recession hit in 1929, national gold reserves could not cope with the increased demand for redemption. By 1933, most western nations ended up defaulting on their gold redemption obligation to individual holders of their currencies. As part of a post-default anti-gold campaign, gold ownership in the USA became illegal from 1933 to 1974. Individuals continued to be subject to criminal sanctions until America defaulted on its inter-governmental gold debts. Post-default relief from pressure on US gold reserves caused American gold trading to become legal again.
This long history of currency and gold standard mismanagement caused the insertion of article 4, Section 2b of the IMF's Articles of Agreement. It specifically prohibits member states from fixing currencies against gold. As a result, with hopes of stabilizing its emerging market currency, instead of fixing the yuan against gold, starting with the Asian Financial Crisis of 1998-1999, China fixed against the US dollar. In July 2005, the "fix" was changed to a managed float. The renminbi strengthened by 21% between 2005 to 2008. In August 2008, the policy changed back again. China 're-pegged' until June 2010 when pressure from the USA caused them to drop the peg again. For more on China's exchange rate policy, see this.
China's fix and/or managed "float" both insure a weak yuan. This causes Chinese goods to be cheaper than similar goods sold by western counterparts. That is a huge competitive advantage.
It supports employment and, therefore, political stability. Simply put, so long as the vast majority of Chinese workers are gainfully employed, they are less likely to revolt. The chance that China will suddenly give up a decades-long cheap currency policy, and destroy that stability, is nearly zero. China's leadership is not buying gold to go on the gold standard. It simply wants the power to set reserves and, therefore, currency values, particularly the yuan vs. US dollar ratio.
A recently declassified transcript of a recorded conversation between former US Secretary of State, Henry Kissinger and his Undersecretary for Economic Affairs, Thomas O. Enders, helps in gaining a better understanding of this issue. It reads, in pertinent part, as follows:
Mr. Enders: It's against our interest to have gold in the system because for it to remain there it would result in it being evaluated periodically. Although we have still some substantial gold holdings - about $11 billion - a larger part of the official gold in the world is concentrated in Western Europe. This gives them the dominant position in world reserves and the dominant means of creating reserves. We've been trying to get away from that into a system in which we can control ...
Secretary Kissinger: But that's a balance-of-payments problem.
Mr. Enders: Yes, but it's a question of who has the most leverage internationally. If they have the reserve-creating instrument, by having the largest amount of gold and the ability to change its price periodically, they have a position relative to ours of considerable power. For a long time we had a position relative to theirs of considerable power because we could change gold almost at will. This is no longer possible - no longer acceptable. Therefore, we have gone to Special Drawing Rights, which is also equitable and could take account of some of the less-developed-country interests and which spreads the power away from Europe. And it's more rational in ...
Secretary Kissinger: "More rational" being defined as being more in our interests or what?In other words, whoever controls the price of gold against their own currency controls the price of gold against any other currency that gold is denominated in. When China increases the number of yuan it takes to purchase one ounce of gold, the dollar will respond by rising in value, even though China will not be pegging its yuan directly against the dollar. The dollar's rise could only be capped by a concerted effort by the USA.
Control over the worldwide currency markets is why China wants to control the gold market.
It is already taking affirmative steps to establish that control, and that is what is behind the announcement that the Shanghai Gold Exchange will establish a yuan-based gold fix before the end of 2015. The chairman of the SGE, Xu Luode, has been not been shy about it. He has very openly stated that China intends to control the gold market. He stated:
The international board will form a yuan-denominated gold price index system named "Shanghai Gold". Shanghai Gold will change the current gold market "consumption in the East priced in the West" situation. When China will have a right to speak in the international gold market, pricing will get revealed.The yuan-based gold price, in other words, will be set at the SGE, which is nothing more than a clearing house similar to exchanges in the West, in that it is sponsored by banks. The difference is that the Shanghai Gold Exchange is sponsored by Chinese banks with direct government support.
Even in the $5 trillion + London currency and gold markets, which are supposedly the most transparent in the world, a few large banks managed to manipulate and control the price of both gold and paper currencies. These banks are even now paying multi-billion dollar fines to various regulators, in an attempt to avoid prosecution.
In contrast to the predominantly private London banking structure, the largest most important banks in China are key tools of central planning and largely state-owned. Yet, under the guise of a "free market", the Chinese government will set the price of gold. The "market", indirectly controlled by China through its state-owned banks, is a convenient mirage. China's leaders will be able to unilaterally increase or decrease the yuan based gold price. The exchange rate, therefore, between the yuan and US dollar must automatically change too, because both currencies denominated against gold.
If China increases the number of yuan required to buy a troy ounce of gold, for example, the USA must allow the dollar gold price to rise with it. If not, the yuan will fall against the dollar.
In other words, China will determine the value of the US dollar on world markets, not the USA.
That shifts the power and leverage away from Washington DC and toward Beijing, and will have a dramatic effect on the financial strength of the US government.
Signeurage is the revenue arising out of creating money. This is because it costs nearly nothing to print paper money, and even less to "print" its electronic version. Yet, this money can be used to buy real things, like oil, houses, cars, plant and equipment. As the printer of the world's reserve paper currency, the USA receives a huge signeurage payment every year. The dollars are printed, used to pay for stuff purchased from foreign lands, and then stored overseas in various places, including central bank vaults, and the mattresses of Russian babushkas.
Every nation and person buying dollars and/or dollar denominated bonds gets to pay, in part, for America's social programs, newest aircraft carriers, stealth fighter jets, drones etc..
Worldwide financial instability since 2008 resulted in the absorption of about $3 trillion dollars newly printed by the Federal Reserve, for one example. The US government has had the benefit of the equivalent of hundreds of billion dollars every year. It will be hard, maybe impossible, to replace that income.
The ancient Chinese strategist, Sun Tsu, is clearly the inspiration for China's massive gold accumulation. If you read his famous book, The Art of War, you may note that he recommended destroying enemies by attacking their economic base, rather than by mounting overt physical attacks. That is exactly what China is doing to the USA. America's policy-makers have stumbled into China's trap.
Once China has enough gold, it will bid up the yuan-denominated price into the stratosphere.
Once it does that, there are only three choices. First, maintain credibility and the reserve currency status by refusing to change the price of US dollar denominated gold. If it does that, domestic industries will be crippled by Chinese competition, because the yuan will become very cheap in relation to the dollar.
Second, allow the dollar denominated price of gold to skyrocket in synch with the yuan denominated price. That will end the US dollar's reserve currency status. Third, kow-tow to Beijing, seeking a seal of approval from China for any serious financial maneuvers.
None of America's choices are good ones. At this point, no matter what the USA does, China wins.
Making things worse is the fact that it will be nearly impossible to prove China is a "currency manipulator" based on the IMF rules. China will simply point to the SGE, explain how the price is set by supply and demand, and win any arbitration brought against it.
It is impossible to know the exact date China will launch its final effort to strip America of its power and authority in the world. But, the current massive gold buying is clearly the main step necessary to do so. China is determined to take power, revenues and international leverage away from the USA.
Meanwhile, hapless US policy makers appear to be blissfully unaware of what the Chinese are planning.
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