A Voracious Appetite
China is currently importing gold in unprecedented amounts, and doesn’t plan on slowing down in the near future. In fact, the forecasts that the country’s gold consumption state that it will more than double by 2015.
These numbers should alarm gold investors in the West for a number of reasons, for even though China has been the world’s biggest gold producer since 2007, the prodigious tonnage mined within the country does little to sate the national appetite. Chinese gold mining companies are even adeptly acquiring more and more production opportunities abroad. China just can’t get enough gold.
Currency War Strategies
Many analysts believe that China’s insatiable hunger for the element is one strategy that the country is employing in its bid to make the Yuan a reserve currency.
According to the World Gold Council, only 1.6 percent of China’s official reserves were comprised of gold as of mid 2012. This scanty number is not alarming when compared to global gold hoarding incumbents, like the U.S., France and Germany, all of which hold around three quarters of their official reserves in gold.
However, this number is exactly why China’s gold consumption has gone through the roof recently. If China plans on the Yuan being held in reserves worldwide, gold is going to play a major role in the currency’s transformation.
China says it is fed up with the inimical mishandling of the U.S. dollar by its own issuing government, and is actively promoting the use of the Yuan in international trade and investment. A Reuters article on the topic claims that this is both “narrowly commercial” and “sweepingly strategic.” The first because it lowers transaction costs for Chinese exporters and importers; and the second, because:
Displacing the dollar … will reduce volatility in oil and commodity prices and belatedly erode the ‘exorbitant privilege’ the United States enjoys as the issuer of the reserve currency at the heart of a post-war international financial architecture [Beijing] now sees as hopelessly outmoded.
China believes that the dollar has had its day, and now its time is up. In interviews with the Wall Street Journal and the Washington Post, Chinese President Hu Jintao stated that the world’s monetary system backed by the U.S. dollar as its anchor currency was “a product of the past.”
Rumors have spread that this signals a return to the gold standard, however, a report from the London-based Official Monetary Financial Institutions Forum (OMFIF) states that that is highly unlikely.
The Yuan’s ability to challenge incumbent reserve currencies has also been brought into question, as it currently does not meet any of the three requirements of a reserve asset: it is not fully convertible; it doesn’t provide plentiful liquidity; nor is it a store of value that investors wish to hold. But China is actively—and efficiently—trying to change that.
If the Yuan does begin to challenge the USD’s position on the reserve currency totem pole, we will definitely see the effects in the price of gold. The OMFIF report states that considerable volatility in foreign exchange rates would plausibly accompany a shift to a multi-currency reserve system. This volatility and uncertainty as the global economy equilibrates would affect gold in the form of consistently higher prices.
The report goes on to state that, “for central banks concerned with preserving value and [being] politically cautious, gold is likely to prove a haven from currency storms.”
What investors can take away from this is that, even though the Yuan may not usurp the U.S. dollar’s throne in official reserves, it will most likely disrupt the current global monetary system, and may weaken the economic power basis the U.S. currently enjoys. And this disruption will cause gold’s value to rise in the future.
Investors Should Prepare Themselves
All of this continued and impending economic uncertainty means that physical gold is the safest investment one can make now. Gold has historically had an inverse correlation to currency valuation, and the world’s most powerful currencies are devaluing and will continue to do so as the world’s monetary system adjusts.