By Lawrence Williams
To become part of the IMF’s SDR basket, China will almost certainly have to unpeg its currency from the US dollar. A massive increase in its gold reserve may be an integral part of this process.
There has been much speculation in recent weeks regarding the likelihood of China announcing a much bigger gold reserve as a prerequisite for possible inclusion of the RMB (renminbi – or yuan the words are effectively interchangeable in terms of the Chinese currency) into a reset Special Drawing Right as a preliminary move towards recognition of the yuan as a global reserve currency. China has gone on record as suggesting that this should happen. Discussions within the IMF on a possible revision to the SDR will commence next month. But it is also apparent that there is little point in the yuan being brought into the SDR while it remains pegged to the US dollar. The idea of the composition of the SDR basket of currencies is that it should represent broad currency stability and having two significant components pegged directly to each other would rather defeat the point behind it.
So, if we assume that a prerequisite for the inclusion of the yuan in a revised SDR basket will be an unpegging of the yuan from the dollar this opens up all kinds of interesting prospects and theories and I am indebted to Dr Fraser Murrell in Australia for pointing me to a fascinating, and apparently little read so far, article on the subject by J.C. Collins entitled: When Will China End The Dollar Peg which sets out all these factors in detail. I would commend anyone following this subject to click on the link and read it.
Dr Murrell goes further himself with a suggestion that the recent strength in the US dollar may not be quite what it seems, but given the peg to the yuan it actually represents strength in the yuan dragging the Dollar up with it ahead of the unpegging of the currencies and a resultant sharp rise in the global valuation of the yuan. Who knows?
But the ramifications of the above are that an announcement that China now holds gold reserves considerably in excess of the 1,054 tonnes it has reported since 2009, the possible inclusion of the yuan in a revised SDR, and the unpegging of the yuan from the Dollar are all inextricably linked and the countdown to this is already under way.
The IMF will be holding a meeting in May which will start to discuss formally any revisions to the composition of the SDR. A second meeting will be held in October which will confirm any new changes and the revised SDR basket will come into operation on January 1st 2016. If the yuan is to form part of the new SDR, then the announcement of its unpegging from the Dollar would have to take place prior to the October announcement – or so the theory goes.
Where does gold fit into this equation? Again it is widely believed that China has been building its gold reserves to a much more substantial level – See: Does any nation hold the gold it says it does? The theory is that the Chinese believe that even a partial gold backing of the yuan will hugely enhance the global financial credibility of its currency in moving it to the next level in global trade. Its inclusion in the SDR basket would be a part of this and, with the size of its economy set to overtake that of the US, its unpegging from the dollar would further improve its global convertibility and help make it a de facto reserve currency as far as global trade is concerned. If all this falls into place this year, as some believe, then January 1, 2016, would be the beginning of the end for US global financial hegemony!
Given the announcement of a major increase in Chinese gold reserves may all be a prerequisite for these changes all coming together, then there would an undoubted impact on the price of gold. Once China has built its gold reserve to the required level it would have no interest in helping to maintain a depressed gold price level – indeed it may feel that it is better suited to command higher prices and could utilise its huge forex reserves to cement its global position in this respect.
Now maybe we give China too much credit in planning such a path to global financial dominance, but as a centrally planned economy with enormous foreign exchange reserves it certainly has the capability of following such a path. With a rapidly growing middle class, which it has been actively encouraging to invest in precious metals, a steadily rising gold price to help keep this key part of its population content, might seem to be very much in its best interests. Again this is something it would seem to be able to accomplish if it so wishes. One can’t but believe that this path has not been in the thoughts of its leadership and it could soon be coming to reality.