Cross-posted from Investing in Chinese Stocks.
Here are snips from a long piece on gold’s role, or lack of one, over the past 60 years.
The KMT’s plan to transport central bank gold to Taiwan was accidentally discovered by Western media and immediately reported. The widespread “gold run” on banks in Shanghai that ensued in the weeks afterward dealt a death blow to the regime’s recently issued jinyuanquan, which had already been teetering on the brink of collapse. This also brought an end to the monetary system that the ROC government had been trying hard over the previous 10 months to build based on jinyuanquan, which was supposed to be strictly pegged to gold.
Many Chinese people at the time were either forced to exchange their foreign exchange and gold for jinyuanquan or did so willingly out of faith in the ROC government. The government, however, issued the currency at will and caused severe inflation. This cost it all the trust it might have had in the part of the country it still controlled, and was a major reason behind the KMT debacle that ensued. That was a lesson that its rival, the Communist Party, has carefully taken to heart.
On the very day that the first shipment of gold left for Taiwan, the party founded the People’s Bank of China in Shijiazhuang, Hebei Province. This marked the birth of the current central bank and the yuan as its statutory legal tender.
The CCP allowed other currencies at first, but gradually replaced them with the yuan:
Things began to change as communist troops started prevailing in larger parts of the country. Inflation began to affect some liberated zones, especially coastal Zhejiang and Jiangsu provinces, where a more developed commercial sector attracted more material goods than anywhere else. Once in Shanghai, a severe crisis involving silver dollars, cotton yarn and grain erupted, a problem the authorities barely managed to control. The crisis was a battle over reserves of important materials fought between the new administration’s currency – the yuan – and the old regime’s payment instruments.
In 1950, the People’s Bank of China began exchanging all existing dongbeibi – a currency used in the northeastern part of the country – for the yuan. It had allowed dongbeibi to exist in the year after the new government was established because it wanted the northeast to be economically independent and strong enough to serve as a supplier of materials. The strength of the dongbeibi lay in the economic foundation the Japanese had established during their occupation. It was also a kind of “goods-backed currency,” as its value depended on the trade of grain and meat to the Soviets in exchange for military materiel.
Taking dongbeibi out of circulation signaled that the party was going to expand the scope of the yuan to the entire nation. By this time the economic and financial systems established by the various regimes that had controlled the nation since the 1911 Revolution were all gone. With the exception of Tibet, which kept its own currency under the Seventeen Point Agreement for the Peaceful Liberation of Tibet, the yuan was made the only legal currency in all of China.
Although gold plays no role in the value of the yuan, maybe it should:
The price of gold started plummeting in early 2013 as the U.S. economy became stronger and the market expected the Federal Reserve to stop its policy of so-called quantitative easing. Meanwhile, China’s demand for gold soared. In the first half of 2014, imports skyrocketed, prompting speculation that the central bank was secretly beefing up its gold reserve.
Buying more gold seems to be a good choice for both the government and individual investors, given the new domestic and international circumstances. The yuan has been relatively stable throughout the most troubled times of the financial crisis, but its peg to the U.S. dollar means it will always fluctuate in sync with the latter, depending on the Fed’s moves.
That is why it is extremely important that we have an “anchor” ourselves.
Gold is a currency that supersedes sovereignty issues, is politically neutral, and is not easily manipulated by monetary policy. Gold may not be able to compete with the currencies of the world’s major powers, but it can certainly be used as an anchor.
Hedge fund manager Li Sheng concludes with:
In a 1966 essay, former Fed chairman Alan Greenspan wrote that gold is “a protector of property rights.” This is true, but only in times of peace and in an open environment. The old wisdom of hoarding gold in troubled times is applicable only to eras of strife and war. In China in the 1960s, in Nazi-controlled Europe and in the Soviet Union under Stalin, gold could not buy one food, let alone protect property.
So instead of trying to peg the yuan somehow to gold to increase its credibility internationally, the government might as well work to establish rule of law and create a system where private property ownership is respected and the public believes in the strength of the monetary system. Confidence is more important than gold.
But that does not mean the yuan system does not need gold. It can be an anchor that stabilizes the yuan and increases people’s confidence in it. It can also serve as a check to the power of any one major currency.