On China and gold

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.

Caixin: Yuan and Gold: Old Enemies Should Finally Become Friends
Caixin: 人民币与黄金:荏苒一甲子、干戈化玉帛

Comments

  1. “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.”

    Those who don’t think Gold will have a future role in the international monetary system should rethink their views. I think Gold is heading back to being an anchor point of some kind… in 2009 the PBoC Governor (Zhou Xiaochuan) said:

    “…an international reserve currency should first be anchored to a stable benchmark…”

    & later in the same piece:

    “…increasing SDR allocation to gradually replace existing reserve currencies with the SDR.”

    6 years on and we have China pushing strongly for the Yuan’s inclusion in the SDR basket, something that may occur later this year (review is due).

    So is the future IMS an SDR denominated reserve currency (Unit of Account) which is somehow anchored to Gold (Store of Value)?

    Some think the gold bugs are crazy, but I’m inclined to think that anyone not owning at least a little physical Gold is even crazier…

    • BB Could gold be more valuable as a store of wealth as money gets cheaper or less as deflation takes hold, or is is it a situation where value is the result of comparative deflations, depending on the rate, which can change according to central bank shenanigans (policy decisions)?

      • IMO if Gold returns to a more prominent role as a wealth reserve asset (used by countries running a budget surplus), the whole inflation/deflation debate takes back seat to what price would be required to accommodate that amount of capital… e.g. look at the size of the US bond market relative to Gold.

    • yield of just 2.2 per cent.

      Whew! Wish I could push my warehouse price to that!!!!

      The value of fiat money is headed towards zero…and maybe faster than we realise.

      • Of course, term deposits after tax are lower than that, ignoring inflation and exchange risk!

        The banks’ conduct requires a tax for a government guarantee! The government requires taxpayers to further subsidise shareholders!

        The public policy is that savers should be punished and speculators (there are no real investors left) encouraged.

  2. To be dismissive of gold’s role in any economy is to ignore human psychology. Chinese gold miners in Australia would smuggle their gold home in caskets and avoided at all costs swapping the shiny metal for pieces of paper who’s ink was still wet.

    The psychology of Chinese is not really different from our own, in recent times they have tried to store and ‘corner’ wealth in real estate more recently in stock markets and overseas RE.

    If that doesn’t work as a store of wealth, what will happen next?

    When money is worthless and other assets become liabilities then there is a place for gold.

    As to the examples of gold NOT being beneficial in times and locations of extreme crisis, I say gold created a class of survivors. (opinion)

  3. “The old wisdom of hoarding gold in troubled times is applicable only to eras of strife and war”
    Pretty much just started happening yesterday with Saudi Arabia’s attack on Yemen…

  4. It has been shown by James Turk that between 1983 and 2002, the People’s Bank of China(PBoC) probably hoarded 25,000 tonnes of gold.
    Since 2002 it has hoarded a further 9,500 tonnes and since 2002 the people of China have been allowed to buy gold.
    So 34,500 tonnes is a serious amount of gold when considering the USA supposedly has 8,500 tonnes.
    When you consider that the BRICS also includes India and Russia who also take gold seriously, then the idea of having gold backing their currencies is a serious option.

  5. Before Gold some cultures like China and central – south America Jade was ultimate icon of wealth and power. The sociological observations of change wrt to the transition, inclusive of the two or preferences is quite interesting imo.

    Even in today’s world precious stones are superior in price metrics, portability, durability and falsifiability. The psychological precursors and cartel activity’s which imbue such objects with such emotive reasoning is quite the anthropological side show.

    As noted in “5000 Years of Debt” gold was one of the preferred mediums to facilitate exchange with others when – trust – was an issue. Yet other goods were superior as want necessitated, silk, spices, tobacco, opium, or other exotics. All of these were bottleneck economic agents, purveyors of such stuff seemingly always become wildly wealthy, without much actual broad social productivity, funny that.

    Skippy…. long story short… will an object force humans to engage in socially productive activity’s or will it have just the opposite effect….

  6. When the United States’ banks were insolvent in 2008,
    they were bailed out by the government.
    The next time they become insolvent, as they must, the government will not be able to bail them out.
    At such a time it is comforting to have your wealth in gold than in pieces of paper or digits on a computer representing credit created by banks.
    Many people prefer the latter, but gold has shown to be
    valuable in those circumstances.
    After the banks have been bailed-in, perhaps people will be happy to exchange their gold for paper again, but they could be tentative about their decision for some time.

    Skippy….those that hold the gold, make the rules…

    • No… those that make the rules decide e.g. derivatives are senior in bankruptcy i.e. they don’t ask for payment in Gold.

      “those that hold the gold, make the rules…”

      In antiquity the law makers forced the use of gold, as a medium of exchange, gold did not force them to use it. You might also look into the decline of the Spanish empire when its fleet of gold and silver ships sank during a hurricane in the Caribbean, having looted he Americas. Unfortuitous event as it was at war at the time and sorely needed the funds, in the end they just took more from everyone else.

      Skippy…. its curious how some feel about an object which got its start as religious iconography… as some say history rhymes… I prefer echos…

  7. Even with all the Central Bank manipulation of Gold there really is no better way to protect yourself. For example Gold purchased in Australian $ via the Perth Mint on 2/12/14 has appreciated over 7.5% to todays price — under 4mths ! This because of currencies etc proving Gold’s value in volatile times.

    Sure you have to bear the pain of watching the F&%$#ers game the prices. It’s for holding, not trading & not with borrowed money. It’s to be used to BUY something worthwhile at some time in the future -like a property to live in when the Housing market finally collapes.

    Two excellent links from todays reading:
    http://investmentresearchdynamics.com/paul-volker-gold-was-the-enemy/

    http://www.sprottmoney.com/news/why-price-analysis-is-meaningless-jeff-nielson-sprott-money-news?mw_aref=4f67acbb35fb1902a8ed248176cf991c

    (so think of ounces not $)