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To the degree that the gold price falls (and the dollar rises), we are
witnessing a giant geopolitical chess game in progress.
As you have no doubt heard, Beijing is sitting on something like $2
trillion in excess reserves. It’s actually more than that. According to
Michael Pettit, a noted in-country China watcher, the figure is “pretty
close to $3 trillion” depending on how you account for it.
This massive sum is no guarantee against a China market crash. Pettit
goes on to point out that China’s huge reserves amount to “5-6%
of global domestic product.” This is the same rough percentage as the
total central bank reserves accumulated by the United States in the 1920s.
It was fashionable to sweat the hoard of U.S. reserves back then, just
as it is fashionable to sweat China’s hoard now. In the late
‘20s, John Maynard Keynes spoke of “all the bullion in the
world” piling up in America’s coffers. And yet, despite all that
backstopped loot, 1929 still happened. The 1930s still happened.
More evidence that even a rich-as-Croesus central bank can lose
control, perhaps... or never had true control in the first place. This makes
sense when you think about the monetary
“pipes” analogy we used just recently in these pages.
It’s no easy to trick to pump a vast quantity of cash into the system
without seeing it pool stagnantly – or making the boiler explode.
Bernanke and crew are like plumbers wearing oven mitts. Are the Fed’s
Beijing counterparts really that much smarter?
Of Gold and the Dollar
But anyhow, moving on to today’s inquiry: Does China want a
lower gold price?
In the long term, almost certainly not. But in the short term, maybe
so. Consider the following:
- Via its mountain of
excess reserves, China has the biggest “long dollar” trade
on the planet.
- China hopes to build
a far larger “long gold” position than it has right now.
- When building a
long-term position, lower buy-in prices are preferable to higher.
On balance, a strengthening $USD is a mixed bag for China. The
stronger the greenback gets, for one, the more that U.S. politicians squawk.
(American exporters of manufactured goods want a weak currency, not a strong
one, and they see China as “cheating” by holding their currency
down to spur exports. This creates a natural correlation between a rising
dollar and rising trade tensions.)
A firmer buck is a good thing for China, though, in that the dragon
has such a huge pile of them to dispose of, i.e. to exchange for more useful
assets. When the dollar gets stronger, all kinds of things get cheaper in
relative terms. Like South American farmland, for instance... or metal mines
in Africa... or coal and LNG from Australia... or gold.
The Long-Run Perspective
In the long run, China craves power (or at least the mandarins who run
the place do). Economic power, financial power, military power, you name it.
In getting from here to there – from a world where America is
top of the heap to a world where China is – China will have to do a few
key things to see its geopolitical ambitions met. It will have to dig out
from under a mountain of paper dollars. And it will arguably have to build up
a massive stash of gold, much bigger than the one it has now.
The strategic nature of this endeavor creates some odd incentives in
the short term. Think of two large investors: one who is trying to quietly
buy up the shares of a small public company, and another who is trying to get
rid of a massive stake.
Gold is like the small public company in this analogy. The total
“float” of gold available for purchase is tiny – a few
trillion dollars’ worth at the maximum. (Much of the world’s gold
is in private hands and not for sale.) China is like the large investor
trying to quietly buy up shares.
Given the intimate knowledge of its own long-run plans, China likely
wants to exchange dollars for gold at the most favorable price possible
– which, here and now, means a lower gold price. This is no
different than a large investor wanting to get the best average cost on his
position.
China is like the other large investor – the one who wants to
get shed of a massive stake – in terms of its divesting its mountain of
dollars. In this case, it is a higher price (i.e. stronger dollar value) that
is desirable, as it means a better rate of exchange on greenbacks going out
the door.
Playing the Game
This is why, your editor would argue, China is predisposed to a lower
near-term gold price, not a higher one. As a large buyer with a very
long-term outlook, Beijing wants to get the best prices it can... both on the
dollars it sends out and the metal it takes in.
This is also why, from an investment standpoint, your editor is not
perturbed by a near-term weakness in gold. To the degree that the gold price
falls (and the dollar rises), we are witnessing a giant geopolitical chess
game in progress. The endgame, when it comes, will look very
different.
Justice Litle
Taipan Publishing Group
Justice Litle is the Editorial Director of Taipan Publishing Group
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