Is China’s pot of gold under your rainbow?

Beijing has just revealed a state secret that has gold bugs and inflation hawks all over the world chattering. Since 2003 China’s foreign exchange ministry has been quietly hoarding tons of gold. The big question now is why?

The total increase in China’s gold reserves was publicly announced to be 1,054 metric tons. (A metric ton is 1000 kilograms, which is approximately 200 pounds heavier than the ton we are used to in the United States.) That sounds like quite a lot but it amounts to $30.9 billion, just a fraction of China’s holdings of the U.S. dollar.

Nevertheless, gold bugs jumped on the news that China was buying even though Beijing’s gold hoard is still not impressive by global standards. The newly revealed gold cache accounts for only about 1.6% of China’s total foreign exchange holdings and is little more than one-tenth of the value of the U.S. gold reserve, still the world’s biggest.

But, only six countries hold more than 1,000 metric tons of gold, and China is now ranked fifth in the world. With Beijing’s surprise revelation, China has leap-frogged ahead of Switzerland, Japan and the Netherlands in terms of total gold reserves.

Where is this secret stash of gold coming from? Standard Bank in Hong Kong says China has been buying via government channels from South Africa, Russia and South America. But Beijing says it purchased its 1,000-plus metric tons of gold domestically, which it could do as the world’s largest gold producer.

China appears to be slowly and quietly hedging its bets against a rapid decline or collapse in the value of the U.S. dollar.

Regular readers will recall that China spoke up before this month’s G-20 summit, calling for a new international reserve currency to replace the dollar. It was an unwelcomed challenge to the world’s strongest currency considering the fact that China is now the largest holder of U.S. dollar reserves, with its hoard of various dollar-denominated assets believed to be somewhere between $700 million and a trillion dollars.

It was no surprise to anyone that the G-20 failed to agree on a replacement for the dollar. There was discussion of Special Drawing Rights, (SDRs) an IMF monetary instrument that has gained little traction outside of governmental or banking circles. An alternative suggested by a U.N. advisor was a basket of Asian currencies to create a regional currency in Asia something like the Euro. That is also unlikely to happen given regional tensions.

The alternative is a shocker. There are subtle indications that China is making early moves to replace the dollar with its own currency, the yuan, as a reserve currency, beginning in Asia.

Since last year, China has signed deals with six countries, including South Korea, Malaysia and Argentina, for currency swaps that would inject Chinese money into foreign banking systems. That would allow foreign companies to pay for goods they import from China in yuan, rather than the dollar. Beijing is also taking steps to settle trade accounts with neighboring states using the yuan. In addition China is spreading the yuan’s influence in Asia by making yuan denominated loans and investments in the region.

Accumulating an increasingly large hoard of gold to back up its currency makes obvious sense if your trading partners are to have confidence in the yuan. It is significant that China now has more gold than Japan and there’s no real assurance that we know about all of China’s gold reserves, considering the nation’s secrecy and its preeminence as the world’s biggest gold producer.

What does this mean for investors? It certainly does not mean that we should rush out and buy gold. China moves slowly and subtly. But Beijing effectively called for a new world order at the G-20 meeting, and we are seeing a hint of what this new financial order will look like perhaps a decade or more down the road.

China appears to be laying the groundwork to establish the yuan as the world’s new reserve currency or at least as an alternative reserve currency to the dollar. Beijing called strongly for more say in world financial developments at the recent G-20, and that’s a refrain we’re likely to hear again and again.

Get ready for Shanghai to compete with New York for dominance in the financial system.
The bottom line to prudent investors is this: Diversify your investments internationally, particularly in China as a new financial star rises in the east. Investments in the U.S. may follow the shaky path of the dollar in the years ahead!

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Jim Trippon,
Editor in Chief
China Stock Digest

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