For years now we have been warning of the decline of the US dollar as the globe’s reserve currency. The threat is not so much that the monetary policies of the U.S. are cheapening the worth of the U.S. dollar, but that these are pressing so many other nations to search for ways to avoid the U.S. dollar in international dealings. China has now taken a momentous, structurally adjusting step to change matters in their favor.
The bulk of international trade transactions have nothing to do with the U.S. except through the use of the dollar to denominate their trade. Approximately 75% of global trade is denominated in the U.S. dollar in this way. But the volatility of the U.S. dollar has distorted and damaged, this aspect of global trade. Thus has been created an ideal environment for gold to rise as its importance in the changing global monetary system grows again.
Having been cornered by the sheer percentage of U.S. dollars in their foreign exchange reserves [every nation has this problem] the Chinese are, at last, moving to make their own currency a reserve currency.
The credit crunch and policies taken to rectify it, have triggered these actions by the Chinese. Despite the fact that the euro is an up and coming global reserve currency that has not threatened the almost imperial dominance of the dollar, the arrival of the Yuan as a global currency will reduce the role of the U.S. dollar in global trade significantly. We believe that the recent moves to introduce the Yuan across the globe will shrink the use of the $ in global trade. With the U.S. in decline, will come a fragmentation of world monetary power. In such a climate, gold will be attractive again, as a long-term investment, as a protection against the uncertainties and strains this will cause. It will also become a more vital hedge against local currency volatility. As the Yuan appreciates against the U.S. dollar and other currencies as a consequence of these changes even the Chinese will find gold more attractive as part of the ‘basket’ in which they hold foreign currencies in their reserves and personal portfolios. Will this bring about the ban on Chinese exports of gold and sale of any such exports to the central bank? It is more than probable at some point in time!
So where will all these dollars go? They will have to go home to where they will add to the massive recent issues of dollars and will precipitate inflation dramatically, once the process is really underway. Bear in mind that it is not only the Chinese who will lower the use of the dollar, all nations with an overexposure to the dollar in their reserves will leap at the chance to reduce this percentage and introduce the Yuan to these reserves as a replacement to the dollar. It is a major structural move that is part of the process of dollar de-colonization. It is likely that even central banks will appreciate gold in their reserves again. This will result in a cessation of “Official” gold sales and the accumulation of gold in central bank reserves in an increasing number of countries.
Actions Taken Already to Make the Yuan Global
1. China has agreed a 70 billion Renminbi [Yuan] currency swap with Argentina that will allow it to receive Renminbi instead of U.S. dollars for its exports to the Latin American country.
2. Beijing has signed 650 billion Renminbi ($95 billion, €72 billion) worth of deals since December with Malaysia, South Korea, Hong Kong, Belarus, Indonesia. This, and now Argentina, in an attempt to unblock trade financing that has been severely curtailed by the crisis.
3. Now, the Chinese government has permitted five major trading cities to use the Yuan in overseas trade settlement. This is a very important step towards the establishment of the Yuan as a global and reserve currency.
Shanghai, Guangzhou [The old Canton], Shenzhen, Dongguan, and Zhuhai, are the cities that have been designated for the purpose. Concentrated in the South the Pearl River Delta cities are the spearhead of Chinese exports and already developed to the extent that even the most high tech of products is rapidly approaching international standards.
The Chinese government has watched with deep concern the prospect of it export surpluses [held in the U.S. dollar] move to the point where their buying power will drop heavily. On the horizon sits the prospect of the U.S. dollar being used in as one of four or five global reserve currencies and not as the dominant one! Understandably then, the Chinese government is taking steps now to reduce the risk from exchange rate volatility and the prospect of the U.S. dollar’s buying power falling. With China’s growth to a global economic driver, these moves had to come in time and that time is now.
Consistent with these moves will, eventually, come the ‘floating’ of the Yuan, so that a break in the current managed float of the Yuan tied to the U.S. dollar will allow a separation of the Yuan from the dollar. This will only happen when the Chinese are convinced that the move will not damage the international competitiveness of China. The hoped-for stability that this brings with it will allow Chinese international trade to improve and will cause an appreciation in the international value of the Yuan. The central bank of China is likely to use this appreciation as an opportunity to diversify away from the U.S. dollar, export the Yuan and bring in currencies that accurately reflect the spread of international trade the Chinese have at present. This would reflect the decades-long Japanese policies of exporting goods when the Yen is cheap and exporting capital when the Yen becomes expensive.
The Impact on Gold
While market attention has been riveted on the price of gold a more important feature of the gold market has caused gold to evolve as money, in increasingly difficult times. The concerns of the Chinese are the concerns of all investors particularly U.S. investors the main buyers of gold shares in the gold Exchange Traded Funds. Consequently, this has broadened the base and improved the quality of gold investors worldwide. While the jewelry trade has retreated from gold and scrap sales have supported the supply of gold, the time is coming when supplies will just not be enough to satisfy investors and scrap sales peter out. The only way such investors will be deterred from buying then is a gold price rising out of their buying zones. This will certainly mean an over four-figure gold price.
The fears of investors are outside the gold market and concern exchange rates, massive tsunamis of dollars and other currencies being printed to shore up the present system in the grips of a credit crunch. Many investors are certain inflation is roaring towards us, to spring up, as deflation is overcome. The future of the monetary system is bleak and extreme.
Locally, gold is priced in home currencies and serves as a hedge against the dramatic moves of those currencies. Rapidly, investors are seeing that their price of gold doesn’t reflect only the value of gold, but the value of their local currencies as well. Awareness of gold as a protection against weakening currencies is growing rapidly. This awareness is growing in central banks, sovereign wealth funds, institutions, amongst wealthy individuals and is now spreading to the man in the street. Once sound money backed by assets was forsaken in favor of man managed and created money, the disintegration of the banking system, the credit system and confidence in currencies and economies was inevitable. Only the credibility of and confidence in paper money made it work anyway. That now stands badly mauled with potentially worse to come. But most observers are not buying gold yet! Once they do, sit back and wonder!
As Greenspan wrote decades ago, “Without a gold standard in place, there is little to prevent governments indulging in wild credit creation. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process.” We do not believe there will be a Gold Standard because it is anathema to all bankers, central bankers included. What is likely to happen is that a formula will be worked out where gold can be used to increase the credibility of and confidence in paper money again. Before that discussion comes to reality, individuals and institutions are and will turn to gold. When governments contemplate gold’s use in money again, you can be sure they will want the metal to themselves and exclude Joe public!
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