Archive for November, 2009

China Brings Home the Gold

Friday, November 6th, 2009

Seems China waited until after the Beijing games to really go for the gold. The People’s Bank of China, the nation’s central bank, has of late stocked up on the precious yellow to the tune of about a thousand tons, and is said to be hunting for more. Why?

The PRC’s export-driven growth has put China’s central bank in a spot. Selling all that stuff to the American consumer means importing trillions of US dollars. Financing America’s trade deficit (and thus China’s surplus) necessitates lending those greenbacks back to the United States, which the People’s Bank does by buying Treasuries. But,  in order to keep interest rates low, the Fed has been doing the same thing; buying US debt and effectively printing the money to do so, flooding the globe with dollars. The result has been a precipitous decline in the dollar’s value against most major currencies. A crucial exception has been China’s renminbi, with the yuan remaining steady at about 6.83 to the buck for most of this year.

Without intervention by the People’s Bank, the yuan would appreciate sharply against the dollar, making it cheaper for the Chinese to buy imports and helping to equilibrate China’s balance of trade with the world, especially the US. But China’s central bankers know the nation’s domestic demand cannot yet support the production necessary for the nine percent annual growth the country currently enjoys, and indeed may require for social and political stability. So the People’s Bank goes on buying yet more dollars and suppressing upward pressure on the renminbi.

Thus, the PRC is left with huge and growing dollar reserves, subjecting it to further potential losses from a deteriorating greenback, while its artificially low yuan makes importing raw materials necessary for production  increasingly expensive. This latter price pressure can, of course, lead to domestic inflation, which has never been a recipe for the civil contentment China’s leaders seek.

What, then, is a central bank to do when it must simultaneously hedge against both weakness in the world’s reserve currency and inflated raw material prices? China’s answer, at least in part, has been to go for the gold, literally. Despite the PRC overtaking South Africa as the world’s largest producer (with an annual production of around 280 tons), China remains a net importer of the metal. To be sure, some Chinese demand for gold is industrial, and with two trillion dollars in foreign reserves, the People’s Bank is arguably underweight in its holding of the metal. But the Bank’s move into gold is hardly a vote of confidence in the dollar. Indeed, China’s leadership surely realizes that sooner or later they will have to let the yuan rise, effectively devaluing the dollar against their own currency, so diversifying into gold amounts to a hedge against their own future policy.

China is not alone in this gold rush. India’s central bank, facing similar dollar diversification issues, just bought 200 tons off the IMF at approximately $1,045 per ounce, and reports have the Fund looking to sell another 200 tons and tipping the probable buyer as… yes, China.

The rising Asian nations are accumulating other commodities, both as dollar hedges and to secure raw material inputs to production. Key among these is “gold” of the black kind: oil. These moves are part of a secular shift in the structure of global trade, one whose roll in the recent crisis has been seriously underestimated in some quarters. I’ll have more to say on this later, but for now, the next time someone tells you the rise in gold and other raw materials is just “rampant speculation,” ask if the central bankers of China and India are to be counted amongst the gamblers. If so, then the punters are policymakers, and wagering against them in recent days would have felt a bit like betting against the house.