A collapsing dollar and China’s monetary strategy
This article describes how China can escape the fate of a dollar collapse by tying the yuan to gold. There is little doubt she has access to sufficient gold. Currently, her interest is to preserve the dollar, not destroy it, because it is the principal means of Chinese foreign interests being secured .
Furthermore, a return to sound money requires China to reverse its interventionism under Xi, returning to Deng Xiaoping’s original vision. Sound money can only last if the relationship between the state and the wider economy is properly addressed.
Of all the major economies, China’s is best placed to implement a sound money solution. At the moment it seems unlikely the necessary reforms will be forthcoming; but a general collapse of the global fiat currency regime presents the opportunity for reassessment and change.
In last week’s Insight I examined the position of the US dollar, given the Fed’s current monetary policies, and concluded that the Fed’s dollar is likely to become valueless by the end of this year. The consequences for other major currencies — the euro, yen and pound — are that they are likely to fall with the dollar. This is because they adopt the same monetary policies, the same macroeconomic fallacies, and through the Bank for International Settlements, G7 and G20 meetings agree to continue to be bound by common policies. While the intention is for all to survive by working together, instead it ensures that they all sink together.
The maverick nations are Russia and China. Russia is obviously working towards protecting her currency with gold — there is no controversy there. China’s position is more complex. Her leadership relies on the inflation of bank credit through state-owned banks to finance her infrastructure plans as well as in financing the massive uplift her non-financial private-sector economy has enjoyed since 1980. Yet, she has made aggressive moves to ensure her population owns physical gold and has invested in mine production, making her the largest national producer by far, while ensuring virtually no gold leaves the Chinese mainland.
Having more or less gained control over the world’s physical market, China is the greatest hoarder of gold on the planet. She appears to understand the importance of gold to monetary stability while at the same time playing the West’s neo-Keynesian games.
The most controversial aspect of my previous comments about China’s gold ownership is about the level of undeclared bullion. But the strategy has always been clear. In 1983 the Peoples Bank was given a monopolist mandate by the Communist Party to manage the state’s acquisition of gold and silver, while private ownership remained banned. This fitted in with the Peoples Bank’s monopoly of managing foreign currency dealing, confirming that in 1983 at least, the leadership and its advisors regarded both gold and silver as primarily money.
Nineteen years elapsed before the Peoples Bank opened the Shanghai Gold Exchange, permitting members of the general public for the first time to buy and take delivery of gold and silver. Following advertising campaigns, the market for 24 carat gold jewellery exploded, and together with investment gold, since 2002 withdrawals from the SGE’s vaults have been about 17,500 tonnes, admittedly not adjusted for scrap resubmitted for refining. To be consistent with gold policies after the SGE opened for business, those nineteen years must have been used by China to acquire significant quantities of undeclared bullion. But other analysts assume that the public held some gold illegally before 2002 as well, so about 17,000 tonnes net of scrap for private ownership seems about right.
The opportunity for the state to build a bullion hoard before 2002 was there. Following the bull market ,which culminated on 21 January 1980, gold entered a 19-year bear market taking it from $850 on that afternoon’s fix to a low of $256.8 in July 1999. But by January 2002, gold was still on the floor at under $280. And there were substantial sellers: portfolio disinvestment by Swiss banks, the largest private depositories at that time, left them holding virtually no gold.[i] Central banks and official sources reduced their holdings of monetary gold by 3,450 tonnes, but more importantly gold leasing by them supplied an estimated 10,000–16,000 tonnes into the market (Veneroso, 2005).
Meanwhile, demand was soaked up by the expansion of derivative markets, principally LBMA forwards and Comex futures. In all those years global mine output added 43,800 tonnes. Various parties must have absorbed the gold that wasn’t absorbed by jewellery, which probably accounted for about 25,000 tonnes.
US policy was to rub out monetary history by denying gold as having any monetary role and to be replaced by the Fed’s unbacked dollar as everyone’s reserve currency. A new generation of Harvard-educated Arabs went with the neo-Keynesians, preferring stocks to gold, the opposite of that of their forebears who disliked financial assets, including foreigners’ currencies. But these were also the formative years for China’s adoption of capitalism.
The Chinese leadership, having a high degree of control over its population, is given to long-term planning in the form of five-year plans with longer-term underlying objectives. It is inconceivable that these plans would have omitted a gold strategy, particularly since regulations were put in place giving the Peoples Bank its mandate to build national reserves.
Given all the foreign exchange dealings of the Peoples Bank, handling inward investment in the eighties and growing exports in the nineties, it could easily have accumulated 20,000 tonnes of gold at contemporary prices, representing approximately 10% of foreign currency flows across the bank’s trading desks. Traditional secrecy in gold markets would have provided cover. All the Peoples Bank needed to do was acquire an average of 1,000 tonnes a year, which given the bullion flows and market dynamics in gold’s great bear market would have been achievable without attracting attention.
It is only on the basis of this understanding that we can apply a 20,000-tonne ball-park figure to the unknowable. And since 2002, China continued to import gold in addition to its growing mine supplies to ensure its population ended up with significant quantities of gold as well. Whether intentioned or not, the leadership has ensured large quantities of 24 carat gold are in public circulation, which is important in the event that gold backing for China’s currency is implemented.
In the event of a general fiat currency collapse, many nations have sufficient gold to operate a gold exchange standard, admittedly at higher gold prices than those that prevail today. That is not the problem. In government, treasuries and central banks, there are very few who understand economics proper, being sold entirely on neo-Keynesian macroeconomics. Neo-Keynesian macroeconomics is a belief system unfounded on reality and their Zeus, or Jupiter, is inflationism. Their lesser gods all owe fealty to this one overriding directive. Before sound money can be introduced, they must all be swept from their temples.
China’s worship of inflationism is less institutionally embedded and should be easier to overturn, particularly since Marxist philosophy predicts the end of capitalism, which today would be manifest in the collapse of the capitalists’ currencies. The ability of the Chinese to escape the monetary fates of the West is in theory still there.
China’s interest in the dollar
With all its gold, by monetising it China could kill off the dollar tomorrow. Undoubtedly, this financially nuclear option has become a backdrop to her strategy in the ongoing trade and financial war against America. But the idea that by using this undoubted power over the dollar China gains a simple victory if through her actions the dollar is destroyed understates a more complex situation. It is not in China’s interest on many levels, not least because of her ownership of dollars is about $3.4 trillion, of which only $1.5 trillion is invested in Treasuries, agency, corporate and short-term debt in the US. The balance is actively used in loan finance to China’s commodity suppliers, those involved with the belt and road initiatives and other states with which China desires to gain influence.
Destroy the dollar and China’s heft around the world is destroyed as well, because only a small proportion of China’s loan-influence is in renminbi. In that sense, if the dollar collapses America gains a geopolitical benefit over China, her means of international influence being crippled. The Chinese leadership will be acutely aware of the consequences of the dollar’s demise and therefore will do nothing to encourage it. Indeed, if the dollar begins its collapse in the foreign exchanges, we could find China increasingly calling out the Fed on its inflationary policies. But then the Fed’s problem is and will continue to be an inability to stop its addiction to unlimited inflationism.
Source: Alasdair Macleod | Goldmoney Insights