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China’s golden plan

 “All warfare is based on deception” Sun Tzu, 500B.C.

China has the deepest historical appreciation of the dangers of paper money and yet they embrace it like there is no tomorrow.

Have they, like their Western contemporaries, learnt nothing from history? Or are they in fact not only learning from history but from the current mess they see on the other side of the world?

Perhaps, this was all part of the reform process.

When it comes to their economic future, China’s holdings of US debt and their covert gold investment programme are two commonly discussed areas of China’s financial arrangements.

Mainstream America, most likely as a result of the election debates, seems incensed at the ‘currency manipulation’ game being played out by the Chinese.

Meanwhile those interested in gold investment are watching, with some awe, the rate at which both the Chinese government and citizens are stocking up on gold. It’s sometimes like those of us in the West are pointing at China’s gold numbers whilst shouting back at our own central bankers ‘Have you seen this?! Are you not asking why they are doing this? It won’t go away you know!’

Bringing gold investment history to the future

In China we possibly have a country which has learnt how to get the best from various monetary systems which have passed through history.

China’s economic liberalization began in 1978, just 7 years after the West’s modern monetary system was set loose.

Since then it can attribute its 100-fold economic growth to its cheap manufacturing and exports. Wealth has increased within the country, with a huge expansion of the middle class which is estimated to account for around 100 million Chinese people. The cheap exports are, in recent years, thanks to the artificially low yuan and also due to China’s record buying of US Treasuries (vendor financing).

China, has like all rapidly growing countries, experienced high inflation in the last decade or so. This was to be expected and, as we all know, is present (whether official or not) in virtually all nations which have embarked on huge government spending programmes to boost the economy i.e. US and the UK.

China hasbenefited hugely from crass, loose monetary policies in the West, most undoubtedly from the US from whom China holds over $1 trillion worth of debt. But they have been clever, not only do they hold the world’s biggest currency manipulators by the cajones, but they are also stocking up for when the US really screw up their currency.

Vendor financing is all good until the buyer/borrow’s debts get too big and interest burdens cripple their ability to keep participating.

The Chinese are wisely cutting down on US debt and they are buying gold.

Holding the stars and stripes

With or without gold, Beijing has big plans for reforming the monetary system. They have been busy encouraging the use of the yuan in cross border transactions. This is not just to reduce transaction costs for trading partners, it has more strategic effects. Namely to reduce the ‘exorbitant privilege’ enjoyed by the US as a result of running the world’s reserve currency and favourable post-war economic conditions over 40 years.

According to a Reuters article last month, Beijing are keen to see greater competition in the international currency markets “competition among major currency issuers and a wider menu of options when investing, trading or seeking a store of value would produce better results for the world economy…with more alternatives, the margin for the U.S. would be greatly narrowed, which will certainly weaken the power basis of the U.S.”

Needless to say the US dollar still holds supremacy and therefore China must be careful how it goes about transforming the face of internationally traded currencies. At present there really is no obvious alternative to the dollar. Any hostile moves towards the US dollar will impact China’s immediate wealth significantly, not to mention any easily US enforced embargoes as seen currently in Iran.

But why would China want to do this considering they hold over $1 trillion of US Treasury holdings?

Earlier in the summer Reuters viewed documents which showed the PBOC had been given direct a computer link, by the US Treasury, to buy US debt in June 2011 as opposed to going via Wall Street.

But something else started happening in June 2011, China began to reduce its holdings of US Treasuries and has been doing so ever since; last month there appeared to be little buying interest at all with Japan’s US Treasury holdings set to overtake China’s.

As Dan Amoss tells us, and is reiterated by Zerohedge’s graph below, ‘Chinese leaders acknowledge that the country already has enough U.S. Treasuries, and have allowed their Treasury portfolio to shrink slowly in recent months.’

Chinese and Japanese US Treasury Holdings

China are no longer as concerned with holding US debt as they once were, China has been fed up with the US’ treatment of the dollar for some time, their enthusiastic purchase of US debt in the past is the only reason the US has been able to keep going for so long. As the Communist country develops its infrastructure, education and industry a cheap yuan is no longer the only way to increase growth.

The reduction in US Treasury holdings by China is one of many on-going moves by Beijing to make their own and the international monetary system more stable and competitive.

Beat the dollar with gold investment

Whilst demand for most commodities in China has been sapped somewhat thanks to the global slowdown, the same cannot be said for gold. And it is at the forefront of financial change in China.

In 2011, gold demand in China increased by 20% and accounted for 21% of global demand according to the World Gold Council. In the first half of this year the country overtook India as the world’s biggest gold consumer – with expectations that China will increasingly gap India as a gold buyer.

Holding gold is, as we all know, a hedge for the un-backed paper currency. Not only is China highly exposed to the US Dollar, it is also exposed to the falling fortunes of the Western world and of course, the swing back from their own.

With the deepest memory of the dangers of paper money it is not surprising domestic demand for gold is said to be ‘only just the beginning’.

Last week, as part of the fanfare around the Chinese Communist Party Congress the government announced it aims to double income per capita by 2020 from 2010 levels. This is likely to only be achieved by pursuing fiscal and monetary actions which may help growth and income in the short term, but in the long term will be highly supportive of precious metal prices and demand.

Alongside this increased income the government are also making it easier for citizens to invest in gold.

Eight years ago the PBOC Governor laid out a plan to integrate gold into the financial system. This was reiterated in Monday’s speech by the current general director of China’s central bank who reminded the audience of the ‘very important’ role played by gold in the formation of the financial market system.

Next month, the Shanghai Gold Exchange will launch an interbank market which will start with spot contracts before gradually offering forward contracts.  On a more accessible level major Chinese banks allow investors to contribute a small amount of money each month in order to gradual accumulate gold and silver month by month. Eventually the investor is able to take physical delivery.

The international gold-backed yuan

Much of the chatter since the LBMA conference this week has been around China’s desire to increase its gold reserves to levels similar to the US’s. With levels of only 2% compared to the US’s 75%, the country will have a long way to go. If this is what they’re doing (it is) then who can blame them for keeping it quiet (they haven’t disclosed details on gold holdings since 2009). It would not be in their interest to announce a desire to buy a few thousand tonnes of gold, it would send the price of gold sky high and the value of those US dollar denominated US treasuries into a black hole.

Even for those who have just clocked onto China’s voracious appetite for gold, it is not a surprise theory that they are preparing the yuan as the new global reserve currency, either alongside or instead of the US Dollar.

For many observers this seems an impossible feat, particularly if they expect to compete on a gold-backed basis. But, as Laurie Williams points out, ‘at current annual production and import levels, between them reaching around 1250 tonnes, and rising, this could be achievable in a far shorter time than many have anticipated.’

A few years ago a task force was set up which the aim of looking at increasing China’s gold reserves. As Zerohedge report, State Council advisor ‘Ji’ was quoted saying in 2009, ‘We suggested that China’s gold reserves should reach 6,000 tons in the next 3-5 years and perhaps 10,000 tons in 8-10 years.’

Earlier this week, conveniently in the mists of the Communist Congress, the China Securities Journal featured a commentary from Goa Wei, a key government official. He writes ‘China needs to add to its gold reserves to ensure national economic and financial safety, promote yuan globalization and as a hedge against foreign-reserve risks.’ He believes the current gold reserves are ‘too small’.

The measures put into place by the government to assist gold’s role in the financial system  show the Chinese government’s way of picking up on the increasing demand for gold-backed products and physical gold and ‘facilitating’ them. Moves such as those mentioned above are taking China in the right direction to become the world’s largest holders of gold.

Earn paper, invest in gold

Whilst China seems to have enjoyed the fruits of Keynesian and Westernised economic arrangements, they know not to reinvest it into similar theories.

They used purchases of US debt to boost demand for cheap manufacturing; they’ve reinvested some of that money into developing more superior industries and infrastructure. Their people are wealthier but they are encouraged to buy gold.

China seems to be firmly on the path to global power, and they are working hard to make sure that path is paved with golden economic stability. They have achieved what they wanted to and they are now investing in gold, fully aware of the sharp edge Western economies are currently balancing on. Whether this results in an international reserve currency system, who can tell, but whatever happens China seem to be getting a better understanding of where to put their wealth compared to the rest of us.

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Please Note: Information published here is provided to aid your thinking and investment decisions, not lead them. You should independently decide the best place for your money, and any investment decision you make is done so at your own risk. Data included here within may already be out of date.

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About the Author

Jan SkoylesJan Skoyles is Head of Research at The Real Asset Company, a platform for secure and efficient gold investment. Jan first became interested in precious metals and sound money when she met Ned Naylor-Leyland whilst working alongside him in the summer of 2010. Jan then went on to write her undergraduate dissertation on the use of precious metals in the monetary system. After graduating from Aston University in 2011 Jan joined The Real Asset Co research desk. Her work and views are now featured on a range of media including BBC, Reuters, Wall Street Journal, Mail on Sunday, Forbes and The Telegraph. She has appeared on news channels including Russia Today to discuss the gold price and gold investing. You can keep up with Jan's commentary by subscribing to our RSS feed Gold Investment News.View all posts by Jan Skoyles

  • L Ron Hubcap

    China’s not the first nation to get wise to the game. They’ve got smart in the same way Opec did, and also in a different way they emerging nations with the IMF and their loans and a million conditions.

    A rigged dirty game in the currency wars.

  • George

    Our central bankers and leaders in the West better have a good plan up their sleeve to combat this… otherwise we’re looking at massive levels of ‘asleep on the watch’ and dereliction of duty.