Normally secretive about its finances, the Chinese government revealed in July of 2015 its gold reserves for the first time in six years. The total is 53.32 million troy ounces, up 57% from the end of April 2009, the last time the People’s Bank of China reported its reserves. According to the International Monetary Fund, the U.S. has 261.5 million ounces of gold, followed by Germany, Italy and France, and now China in fifth place.
However, gold analysts strongly suspect that China is understating its holdings. “The figure published by the PBOC [People’s Bank of China] is roughly half the market consensus on what we had thought they had accumulated,” said Ross Norman, chief executive of London-based bullion broker Sharps Pixley. Other analysts agree.
China has steadily increased its gold reserves, which rose by 480,000 troy ounces, (14.9 tonnes) to 54.93 million ounces (1,708.5 tonnes) at the end of September, the People’s Bank of China (PBOC) reported. The central bank added 16.2 tonnes in August and nearly 19 tonnes in July, 2015.
In addition to importing, China mines a great deal of gold. China is the top gold producer in the world, surpassing the combined efforts of the US and Russia. It does not export, and apparently keeps all its gold for government reserves and possibly for sale to its own citizens.
The Chinese people have trusted gold as a store of value for centuries. China has a long history of dynasties and governments rising and falling along with their fiat currencies. No country, except perhaps India, has a longer and deeper sense of respect for gold as a means of preserving wealth in good times and bad.
Why is the World’s 2nd Largest Economy Consistently Acquiring Significant Amounts of Gold?
The most obvious reason is that China holds massive foreign currency reserves, most of it denominated in U.S. dollars. Its foreign exchange reserves, the world’s largest, were $3.514 trillion as of September. “China’s foreign reserves consist overwhelmingly of US dollar claims, mainly US Treasury bonds, which is a strategic weakness, because in case of war these can be frozen, as Iran knows too well. It is imperative for China to increase the gold content of the reserves and to diversify the rest into other currencies.” F. William Engdahl, “Russia Gets Very Serious on De-dollarizing” June 6, 2015.
All currencies fluctuate, and the dollar will eventually fall from its lofty perch. When it does, it will reduce the value of China’s foreign reserves considerably. Gold will hedge that risk, and so it makes good economic sense for China to continue buying gold.
The percentage of China’s foreign reserves held in gold is actually quite small. Gold still makes up only 1.7 percent of China’s total reserves, according to Reuters calculations, which should drive the People’s Bank of China (“PBOC”) to continue buying. China should increase its gold holdings to around 5 percent of its total reserves to help diversify currency risks, a World Gold Council representative said earlier this year.
China will undoubtedly continue buying relatively large quantities of gold, but in measured steps. “Gold has special risk-return characteristic, and at specific times is not a bad investment,” the People’s Bank of China said on its website. “But the capacity of the gold market is small compared with China’s foreign exchange reserves, if foreign exchange reserves were used to buy large amounts of gold in a short amount of time, it will easily affect the market.”
Yuan as Alternative Reserve Currency
The US dollar is the world’s reserve currency, meaning most international transactions are conducted in dollars. The most important example is petroleum: oil is bought and sold in dollars. This fact is a huge economic advantage to the United States that most Americans take for granted. Russia and China have been planning for years to supplant the dollar, so far with very limited success.
China is seeking IMF recognition of the yuan as an official reserve currency equal to the U.S. dollar, the Japanese yen, the Euro and the British pound. An IMF decision is expected later this year. Gaining that status could elevate China’s role in global finance. “They want to have a much bigger presence at the international level and they want their currency to be considered a reserve currency,” said Simona Gambarini, a commodities economist at Capital Economics in London. “In order to do that you need to back it up with a certain amount of gold.”
Ken Ford, president of Warwick Valley Financial Advisors, said China has been pressing to be included in the International Monetary Fund’s Special Drawing Rights, or SDR, currency basket. “So they want to show that the have accumulated enough, but do not want to show their whole hand because it may spook the markets,” he said.
The Economist explains how the yuan’s rise would come at the expense of the dollar, and consequently the American economy. “The economic consequences of the yuan’s rise would be momentous. The ‘exorbitant privilege’ that goes with being the issuer of the dominant currency would become a thing of the past for America. Because there is so much demand for dollar assets—more than 60% of all global central-bank reserves are held in dollars—America and companies based there can sell bonds for higher prices than they could otherwise. Since bond yields move inversely to prices, this means it costs less for Americans to borrow—so it is easier for the government to fund its deficits and for firms to raise money.”5
Making it more difficult to borrow would stifle the already fragile U.S. economy.
What Does It Mean For You?
Although it is difficult to speculate on motive, it is a safe bet that Chinese accumulation of gold has a very sound basis. Their culture has survived for thousands of years, based on conservative principles. Those include conservative and successful financial management principles. On a more immediate level, dependence on the dollar is unacceptable to the economic momentum of China. It must diversify its foreign reserves, and one important way to do this is to acquire more gold. Finally, to increase its economic power, China must elevate the status of the yuan to a reserve currency, which objective likewise requires the acquisition of more gold.
If China should choose to use their massive gold holdings to create a gold standard, then the Yuan could easily replace the US dollar as the world’s reserve currency.
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