From FTAlphaville today:
When it comes to China’s gold purchases, there is one other important aspect to consider. It is not clear at all that these purchases are PBOC led. This is important because the meaning of gold purchases by private hands is very different to the meaning of purchases by state hands.
State purchases make sense when the official currency needs debasing relative to the gold price, i.e. when the fiat currency of the land is getting too concentrated and deflationary. By squeezing the gold market, you create a Gresham’s law effect that worsens your money, and forces it into circulation. Gold on the other hand gets hoarded.
Private gold purchases, however, make sense when the official currency is unlikely to be supported by the state anymore, for example when the fiat currency is likely to be floated and when it is unclear that it will be able to maintain price stability off its own accord.
In China’s case, of course, state gold purchases could also be motivated by the state’s desire to back their currency with something more neutral than foreign reserves, reflecting a step towards greater economic autonomy.
…As Freya Beamish at Lombard Street Research notes on Wednesday, if it was really about substituting out of UST and into gold in a move towards greater autonomy, there hasn’t been anywhere near enough imported to make a dent in its dependence on foreign reserves:
Even if all the production and imports were to have gone into the PBOC this would still total little more than 6% of China’s foreign exchange reserves. China’s huge foreign reserves mean that as a percentage of M1 for instance, this higher figure is nearly 5%. In relation to US reserve gold holdings, it is easily over 50%.
…But, again, she concludes — like us — that this is unlikely to be the key motivation. Much more plausible is the theory that private hands are buying gold because they fear that if and when the RMB floats — i.e. when the PBOC stops backing RMB with USTs — the RMB will lose a lot of its purchasing power because it lacks the seigniorage power of the US. This also explains China’s fascination with Bitcoin and all sorts of other competing stores of value (from Rolex watches to London property).
As Beamish notes:
What we can say at this stage is that the ferocious Chinese appetite for gold in all its forms is a clear signal of lack of faith in Chinese liabilities and in the RMB, which we have argued on numerous occasions is overvalued. China is the epicentre of global excess savings so it’s hard to explain the punishingly high nominal and real interest rates without concluding that liquidity is trying to flee the system.
This has become obvious within the country as the conventional part of the banking system loses deposits to the unconventional part. In 2012, it also began to be clear that liquidity is more than happy to flee China given the chance, as the country saw private capital outflows of around $300bn on a four quarter rolling basis.
It is no coincidence that gold imports from Hong Kong really took off in 2011, when we estimate the RMB first entered overvalued territory. Not only does RMB overvaluation make it directly sensible for Chinese investors to dump the currency in favour of gold, it also brings Chinese liabilities into question in general.
With the RMB this overvalued, China now seems incapable of growing without debt injections and that is a situation that can only end in crisis or RMB depreciation or some combination thereof. Gold is a natural hedge in any of those scenarios. The trade data tells a similar story on the RMB. Annual export growth reached a peak of 33% in January 2011 and has slid to a low of 7.2% in January 2014. Part of this is attributable to generally weak global demand but it’s clear that China has suffered a major loss of competitiveness.
Australian assets fit this profile as well if you believe that a float of the Chinese currency would not hit the Australian dollar. But liberalising the Chinese capital account also means floating interest rates and that would accelerate rebalancing away from commodity-intensive Chinese growth and towards more productive enterprise. I still think Chinese buying Australian assets are making a mistake of they think it’s a hedge.