I listened today (20th May) to an exceedingly interesting presentation by Ken Hoffmann, Bloomberg’s Global Head of Metals & Mining Research at the very well attended Global Mining Finance Precious and Base metals event in London. The talk was entitled ‘China: Brace for a hard landing and a new ‘Gold Standard’ and related to research conducted by Bloomberg analysts which was only released about half an hour earlier than the talk.
While Hoffmann may not have answered the question posed by the talk title directly, and a ‘gold standard’ in the old sense may not be realistic given that to back the yuan physically with gold would require either more gold than the world has ever produced (at the current price levels) or perhaps if China can accumulate 10,000 tonnes of gold, a gold price of $64,250 an ounce would be required. (China currently has official holdings of 1,054 tonnes as reported to the IMF, but is widely believed to have accumulated far more held in separate accounts not yet reported to the IMF. Bloomberg analysts suggested it might have an additional 2,500 tonnes in such accounts – others put the figure rather higher, but until and unless China comes clean with a ‘true’ figure we just don’t know – and even then we may still not know for sure given the somewhat opaque nature of Chinese government statistics).
But, regardless of these figures Hoffmann has implied in recent statements that if China were to go with a currency backing by gold it would have to be in some kind of new form. Don’t underestimate Chinese capability of thinking outside the box is something he tells his analysts. “The World needs to think about China in Chinese terms” said Hoffmann – not traditional western ones. And if anyone has a good handle on Chinese thinking, with regular trips there and to Hong Kong, he is one of the better placed westerners to understand the Chinese psyche, and also the Chinese view of gold. This, he reckons, is the Chinese view of the gold standard as being an old system that worked rather than more recent Keynesian attitudes (gold standard is a barbarous relic etc.) which the Chinese feel may have led to throwing the global economy into relative chaos.
Hoffmann pointed to the Chinese programme of setting out its future path economically and it is now entering the third plenum (the first was the anointing of a new leader and the second the setting up of new government systems). The third plenum is setting out the nation’s 10-year economic programme and we are already beginning to feel the effects of this in terms of the consolidation of China’s domestic economy following nearly a decade of unprecedented growth (the driver on its own of the global commodities supercycle).
Part of this plan is to rein in production excesses, particularly at the localities level, while launching the yuan as a truly global currency and some form of gold backing could be a key part of this plan. The Chinese, as do many other nations outside the West, believe in gold. Thus, although the West does not, in theory, it also understands deep down that gold does have a significant place in the global economy – something of a contradiction in attitudes. Hoffmann relates that in talking to senior Chinese officials they told him that in their own discussions with Western Central Banks they are told that gold is irrelevant in this day and age. But when they say ‘if gold is irrelevant, sell us all your gold’ they are met with a blank refusal. Anecdotal, but useful in making a point.
Part of Hoffmann’s thesis is based on Chinese concern that the big Global Financial Crisis of 2008 hit them almost out of the blue and in turn led to that nation’s huge infrastructure building programme requiring vast amounts of raw materials to help counter the potential effects on the country’s domestic economy. Now that phase has come to an end this also represents the end of the supercycle per se and that western resource companies, which were late in coming to the table in building production to meet Chinese demand, have now produced maximum output as the cycle has ended and has been turning down. Much was made of demand emanating from the BRICS economies by global analysts, but in actuality there is no BRICS says Hoffmann – only C for China which has accounted for an enormous percentage of global resource demand growth entirely on its own.
The change in Chinese thinking under this administration’s third plenum will likely create significant internal problems (the hard landing) – hence the massive anti-corruption drive. The State cannot afford to have provincial and central government officials and industrialists being seen to make huge, possibly illegally gained, profits on the backs of the populace when there may be some tough years ahead as the country reboots its economy. And the impact on its trading partners may be equally severe – so be warned.
But the other factor affecting Chinese thinking is global trade and the position of the yuan. Global trade in yuan only accounts for about 2% of the total and China feels that as the world’s second largest economy this position should change and the yuan, if not yet ready to become a global reserve currency, should be much more easily tradable worldwide than it is at the moment. Hence the machinations under way to try and bring the yuan into the basket of currencies which comprise the IMF’s Special Drawing Rights, something IMF Managing Director Christine Lagarde seems to favour, but may be opposed by the USA which fears Chinese yuan erosion of the dominance of the dollar in the global monetary system.
Because of the virtual dollar hegemony which exists at present, and the apparent reluctance of the USA to allow China to progress in this manner, the Chinese have already been thinking outside the box and have moved at lightning speed (in global financial terms) to set up something of a rival to the IMF itself and World Bank in the Asian Infrastructure Investment Bank (AIIB). If they see continued USA-led opposition to their eventual desire for the yuan to become a fully tradable reserve currency, perhapspari passu with the US dollar, then their outside the box thinking may well persuade them to somehow play the gold card – but exactly how this would be achieved is uncertain. But do not underestimate the capacity of the Chinese to come up with their own workable solution to what seems to be seen in the West, as an unlikely – perhaps impossible – option.