Commodity Trade Mantra

China’s Increasing Presence in Gold Market – An Obsession to Prop up Yuan

China's Increasing Presence in Gold Market - An Obsession to Prop up Yuan

China’s Increasing Presence in Gold Market – An Obsession to Prop up Yuan

Barclays, a multinational bank headquartered in London, owns one of the largest vaults in Europe used to store precious metals. But that won’t be the case for much longer.

Barclays recently signed an agreement to sell its storage facility to ICBC Standard Bank. This is a Chinese state-owned bank, considered to be the world’s largest bank when measuring based on assets.

While Barclays is moving away from the precious metals business, China is embracing it.

The vault, located in London, is in a secret location, but is said to be able to store up to 2,000 tonnes of metals. While it is used to store gold, silver, platinum, and palladium, the gold portion is probably the biggest story.

In terms of location, London is the biggest gold player in the world, boasting as the largest wholesale over-the-counter gold market in the world. It is little surprise that the Chinese government wants to have an even greater presence there.

China has already taken a seat at the London Gold Fix, which sets the benchmark price that is used worldwide for pricing gold products and derivatives.

We also know that China has been significantly increasing its gold reserves, although we still don’t know by how much for sure. If anything, its reported reserves are probably understated. And in just the last couple of years, China has overtaken India as the world’s number one importer of gold.

There is no question that Chinese officials see gold as an important asset for the future. It is less certain if China’s quest to put the yuan on the world stage is closely related to this involvement in gold.

China’s Currency and Gold

It was only late last year that the IMF announced that the yuan would be included in its Special Drawing Rights (SDR) basket of currencies.

Perhaps the big question here is whether China is getting involved more in the gold market in order to boost the yuan as a world reserve currency, or whether China is getting into gold as an alternative to the yuan.

There are many people who believe that the central planners in China are actually going to come up with some kind of a gold-backed currency. While I wish it were true, I think it is a long shot at this point, at least in the next several years.

While the Chinese government has liberalized its markets to a great degree over the last several decades, it is still an economy run by central planners. Unfortunately, the downturn in stocks last year in China showed the authoritarian nature of the politicians there, even in regards to economics.

The Chinese economy is heavily manipulated. The entire banking system is basically state-run. And the yuan is still not a freely floating currency.

It is hard to imagine that the Chinese bureaucrats – who are essentially mercantilists – would have the economic understanding to implement any kind of a gold-backed currency, even if they had the best of intentions.

The Chinese interest – some might say obsession – with the gold market these days probably has more to do with propping up the yuan. Even though there are no gold-backed currencies, central banks hold gold reserves for a reason. It is to help maintain a certain degree of confidence in their fiat currencies. In the case of China, it may also be a way to diversify a little, since it holds trillions of dollars in foreign currency reserves.

As an advocate of the free market, I am not sure whether to cringe or to cheer when I hear all of these stories about the Chinese government getting more involved in the gold market.

The banking system should be set free. The money used, along with the interest rates, should be determined by the free market. In a true free market, it is really unnecessary for the government to own any gold at all. It should be the people owning gold.

Still, given the situation of a mixed economy and fiat currencies, it is probably a good idea for governments to have gold reserves. If they are going to centrally plan the economy, they can at least get something right.

At the far end of the spectrum of socialism, we get the current situation in Venezuela where there is mass poverty and chaos. It is no surprise that gold reserves there have been dwindling down, as the government is trying to find any source of funds it can.

So the fixation on gold coming from Chinese officials is neither great nor horrible. It is a story of central planning, but it is diversification that can lessen the devastation of central planning gone wrong, which it always inevitably does.




Courtesy: Geoffrey Pike

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