The Taper, China and Gold—Where Is this Leading Us?


"The announcement the U.S. Fed would start tapering in January knocked the gold price back sharply, but will China step up gold purchases as a result? If so, what impact will that have on price?"


The long heralded taper is about to start and, far from the doom and gloom seen as likely to result in markets across the board by many observers, gold seems to be the only one of consequence to be brought down—so far.

This has much to do with Ben Bernanke's presentation of the U.S. economy as the Fed wishes it to be seen and does not necessarily bear much resemblance to reality if one utilizes statistics, such as those prepared by John Williams' ShadowStats, which looks at the economic indicators in the way they used to be assessed before the government massaged them to present things the way the Administration would like things to appear. As Williams himself puts it: Methodological changes to economic reporting have pushed headline economic and inflation results out of the realm of real-world or common experience. But such is the power of government spin!

To recap, the Fed has been effectively pumping US$85 billion of liquidity into the U.S. financial sector through its bond purchasing program, thereby also keeping real interest rates artificially low (negative in fact) with the intention of boosting the U.S. economy.

The theory is that the low interest rates will encourage companies to invest and thus the high levels of unemployment will come down as the companies do so. Meanwhile the financial sector has all this extra money to play with and the stock market has been rising as a result and this provides a highly visible indicator to the general public that the economy must be improving as stock prices are rising—even if the only ones really benefiting from the process are the financial elite and the small part of the general public which buys stocks and shares.

Inflation figures are massaged downwards and bear little resemblance to those being seen by the person in the street who will be experiencing inflationary pressures which are actually several points higher, and employment is only picking up very slowly.

However the official figures it puts out, whether they bear much resemblance to reality or not—and rising markets, enable the Administration to present what appears to be an ever improving picture to the Public at large—are what the Public reads. In running a country it is what is generally perceived to be happening which keeps the government politicians in power—or not.

Assisted by most of the mainstream media, which is mostly too ignorant, too stupid, or too in the government's and financiers' pockets to assess what is really happening to the economy, all appears well in the state, notwithstanding the 47 million Americans who now receive food stamps—around one-sixth of the population, a proportion which has been growing rapidly since the financial crisis in 2008—despite a supposed recovery.

Meanwhile the Fed policies are piling up the debt. Some $4 trillion at the latest count. Interest, even at current low interest rates means this debt is effectively unredeemable in practice and will have to be written off in time by some means or another if the dollar is to retain any credibility on world markets.

True, the Fed will hold benchmark interest rates near zero and thus appears to be successful in using forward guidance to calm the markets and to convince investors that tapering is not equivalent to tightening. In fact, as Sharps Pixley points out in a note today, the Fed will roll over the maturing Treasuries and reinvest the principal payments of the mortgage debts.

But, initial market reaction to what has been, in reality, the Fed putting its toe in the water to test out how the financial markets would treat a small taper will, if the initial pattern is retained, encourage it to continue the taper—probably in $10 billion increments—throughout the year, possibly bringing its bond buying program down to zero by the end of the year should the markets continue to react benignly. But there are those who believe—some very good brains among them—that once the markets really understand that this stimulus which has been successful in driving the indices up to record levels is really being withdrawn, they may well crash, and that when it comes the crash could be devastating for the investment community.

And if that happens the whole perception, which has been contributing to such growth as there is in the U.S. economy—i.e. people are still spending, if not at pre-recession levels, at least at a sufficient level to keep the economy spinning along—could disappear rapidly. Spending will fall dramatically and the U.S. would be back in a major recession again. And the Fed would be forced to react with new easing programs to try and reverse this.

So where does gold fall in all this. That the gold price has been falling on the taper announcement is of no real significance to the Fed—it is collateral damage, and indeed may even be Fed policy. Gold can go hang as far as the Fed is concerned. Bernanke, nor most of the other FOMC members, just doesn't understand gold's long-term appeal as an agent of financial stability—in fact, gold is an annoying irrelevance in most of today's Western economic thinking, although far from it for much of the rest of the world.

Currently the U.S. and U.S. thinking dominates the global economic structure, but this is inevitably changing and the way things are going at the moment global economic power is slowly, but surely, moving eastwards into areas where gold is seen as having a far more significant role—particularly in implied status of the gold holder. China in particular is seen as being extremely keen to impress the world with its economic and technological power—as witness its recent Moon spacecraft landing.

Anything the U.S. can do China can do better, faster and far cheaper! And gold seems as though it may already be a key player in the Asian Dragon's desire to lead the world economically. The Chinese mantra may well be that the country with the biggest gold reserves controls the global economy. As far as gold is concerned, perhaps size does matter.

Chinese gold imports remain a matter for some debate in the West as, just like the U.S. the Chinese are good at massaging statistics too—and in a controlled economy things may even be better hidden. Nobody knows for sure that China is building up its own gold holdings, possibly at a rapid rate, and they won’t know unless and until the country makes an official announcement upsizing its reserves as it did back in 2009 when it last announced a reserve increase.

The country’s gold consumption this year is variously estimated at somewhere between 1,600 tonnes to perhaps as high as 2,500 tonnes or more. The 1,600-tonnes low figure comes from adding imports through Hong Kong (a reported figure and heading to around 1,150 tonnes, perhaps more) to China’s own gold output, again put at 400-430 tonnes.

The higher figure comes from Shanghai Gold Exchange deliveries (and People’s Bank of China figures, which tend to be virtually identical) plus Chinese gold production. But again no one knows for sure whether this is all being swallowed up by the general populace’s gold buying fever (unlikely at these levels) or whether it includes Central Bank purchases (seen as increasingly likely by many observers and, reading between the lines, also appears to be Chinese policy as often referred to in statements from various Chinese officials.) And then there are reports that North Korea has been selling significant amounts of gold out of its reserves (reported as being considerable) to China to alleviate an economic crisis—but no one can be sure how much gold may have been transferred, if indeed it exists, or how it is delivered. Straight to the Central Bank or via the Shanghai Exchange?

So as Donald Rumsfeld would have put it, as far as gold and China is concerned, "There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don't know. But there are also unknown unknowns. There are things we don't know we don't know." How apposite to the Chinese gold conundrum.

But what we have tended to see is that every time the gold price takes a knock in the West, buying surges in the East and some statistics suggest that perhaps Chinese consumption on its own is getting awfully close to accounting for total annual global new mined gold supply. Can this stabilize any gold price falls? There could come a point when the Chinese government thinks enough is enough and it certainly has the financial muscle to turn things around as far as gold is concerned.

Coming back to Fed tapering, there is a feeling that once the markets begin to realize that the Fed initial taper is perhaps just the start of the complete withdrawal of Fed stimulus they will begin to turn down, while gold (which was seen as a slam-dunk sell by Goldman Sachs analyst Jeff Currie should the taper start to be implemented—as indeed happened!) is likely to recover a little. It could recover a lot if the markets do indeed start to fall back heavily. Bernanke doesn't want the markets to see tapering as tightening—but it could certainly be seen as the beginning of the end of loosening!

Lawrence Williams

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