China’s gold dilemma and strategy
No country has changed so dramatically as China over the last decade as it has grown to challenge the USA as the World’s number one economy. As we entered the last decade the US dollar was strong and recognised world wide as the “reserve currency”. In China, many people refer to the dollar as mei jin, or “American gold.” so if a Chinese person tells you that he owes you 100 American gold, don’t expect a big fortune, because he’s planning to pay you $100. Competiveness in many diverse products meant that countries in the western world were struggling for margin and seeking new ways of cutting production costs. We were to see production moved from Western to Eastern Europe from America to Mexico, to take advantage of lower overheads but it eventually dawned that the cost savings to enable survival could only be made in the Far East. We started to see product coming in from Taiwan and then mainland China where there was an unlimited and cheap work force.
China started the 21st Century with $166 billion in foreign reserves, today it has the worlds largest foreign reserves at $2400 billion and is almost 31% of the worlds total reserves and nearly double the total held by G7 members. During this period the US dollar has been devalued by 30% and the majority of China’s reserves are in dollar assets so it is not in their interest to see a collapse of the dollar. During this period China’s gold reserves rose from 404 tonnes to 1054 tonnes.
Chinese are quite concerned that the large U.S. government deficits will eventually lead to inflation, which will erode the purchasing power of the dollar denominated financial assets. If they keep printing money to buy bonds it will also lead to inflation, and after a year or two the dollar will take a hard fall. Most of their foreign reserves are in US bonds and are very difficult to change. The Yuan’s exchange rates are fixed by the Chinese authorities, this lack of convertibility keeps the Yuan low against the Dollar and avoids speculation on the currency. Labour costs remain very low and prices remain competitive. Making the Yuan fully convertible would be very harmful to the Chinese economy as anything to undermine the Dollar’s value would destroy all their investments and the value of the Dollars they hold. In a way, the US economy and Chinese economy are inextricably linked. The main problem Chinese authorities have is a stock of up to 2000 billion “risky” Dollars and the dilemma they have is how to get out of this situation. The currencies and proportions of foreign currencies held in reserve are a secret but in can be assumed that after the dollar will come the Euro and Yen.
The Chinese need to diversify and according to Cheng Siwei, former vice-chairman of the Standing Committee and now head of China’s green energy driving force. “Gold is definitely an alternative, but when we buy, the price goes up. We have to do it carefully so as not to stimulate the markets”. The comments suggest that China has become the driving force in the gold market and can be counted on to buy whenever there is a price dip, putting a floor under any correction. So this is the second dilemma, China does not want to raise the price of gold, as happened when India bought 200 tonnes from the IMF late last year, but still needs to acquire gold. We are already in a situation where the total world mining production is around 2500 tonnes and it is estimated that demand far exceeds this, hence you cannot turn these days without seeing an advert to buy “old gold” in an attempt to make up the deficit.
If China had bought the IMF gold on offer, the signal this would have sent to the markets could have led to a huge gold price surge and a consequent devaluation of the dollar and, given China’s enormous dollar holdings, this doesn’t make economic sense. Far rather buy the gold under the table from its own producers and hide it from the world at large until such a time it may be economically expedient to announce it.
A salesclerk shows a gold bar with the sign of the Tiger in a Beijing department store
Since 2003, Beijing has been buying most of the gold excavated and refined locally. It was a perfect strategy. No one in the international market became the wiser and the bill was paid in yuans. Today, China has more than 1,050 tonnes in its official vaults, up 75% in six years. Its gold reserves are now the fifth-largest among national central banks after the US, Germany, France and Italy. This insurance helped mandarins in Beijing sleep easier at night.
The Chinese people who have the highest savings rates in the world, have followed their governments lead and have been buying gold as an insurance policy and Beijing has begun actively encouraging people to invest up to 5% of their income in gold and silver. The result is that in 2009 it looks certain that China overtook India as the world’s largest gold consumer. Given China’s explosive growth, which has to be bringing ever more and more of its enormous population into the urban middle classes with ever increasing purchasing power, this ongoing rise in purchases by the Chinese public is likely to continue to expand. There are no figures for 2009 but according to the China Gold Association it consumed 395.6 tonnes in 2008 and an estimate is that the demand would reach 420 tonnes in 2009.
In the long term China craves economic and financial power and would take the place of America if it could but it needs to free itself from the vast amount dollar asset it holds and arguably convert a substantial amount of these to gold. It wants to exchange those dollars for gold at the most favorable prices, so in the short term it does not want a high gold price nor does it want a weakened dollar as it needs to get best exchange rate for the dollars it holds. Most of the world’s gold is in private hands and not easily accessible so China’s option in the short term is to chip away quietly like an investor buying up small numbers of shares in a company before a takeover. China for the third year running has been the world’s largest producer of gold, rising by over 11% to reach almost 314 tonnes in 2009, most of which has been sold for internal use. Also, China has pushed for an alternative reserve currency to the dollar as did Russia before them and the neutral successor is gold.
China is playing a political game and wants a near term low gold price to acquire its precious metal and a strong dollar to convert to other assets at the best price; but in the long term there can be no doubt that China actions will lead to a sustained increase in the price of gold.
Maurice Hall