The Geopolitics Of Gold

A number of events are coming together which are set to push gold prices higher. Besides a combination of continuing inflationary policies and massive future budget deficits undermining the dollar, by closing down derivative market activities new Basel 3 regulations appear set to deflect some demand into physical metals. Furthermore, liquidity in gold markets will contract, potentially making prices more volatile.

China is moving on, enlarging its own middle class which will benefit from a stronger yuan, much as the German and Japanese economies did between 1970—2000. Having dominated economic developments until now, the export trade is becoming less important. With this dependency lessening, the argument in favour of a coup de grace against the dollar by China revealing its true gold position is increasing

In this article, China’s undeclared gold reserves are quantified, and we can be confident that China has at least 20,000 tonnes “off balance sheet”. For China to openly declare her gold position always was her final, almost nuclear option in the financial war waged against her by America. Unwittingly, by diverting demand from paper gold to physical bullion, Basel 3 may have brought forward that day by default.

Gold, Ingots, Treasure, Bullion, Gold Bars, Wealth

Image Source: Pixabay

Introduction

The imminent introduction of Basel 3’s net stable funding ratio is going to have a major impact on the global banking system, and it is a reasonable assumption that government agencies concerned with geopolitical implications will be considering it from that point of view. And nowhere is this more important than for gold, and by implication the dollar’s unrivalled hegemony.

With China having restricted credit expansion for about a year, its economy is in a different position from that of the major Western economies. The US, the EU, Japan and the UK have continued to give credit free rein with zero and negative interest rates. With China at a different stage of its credit cycle, strains are bound to surface across the foreign exchanges. China’s yuan is strong, having risen by 10% against the US dollar over the last year, and it is likely to continue to rise.

It is hardly surprising that the Chinese are warning the West about financial market bubbles. While there may be an element of crowing by China’s monetary authorities about how wrongfooted their Western counterparties have become while they themselves acted against price inflation early, they are correct. I devoted last week’s article to the consequences of ignoring the threat of rising prices, primarily the outcome of ultra-loose monetary policies.[i]

It is worth noting that statements by the Chinese about the US and vice-versa are in the context of an on-going financial conflict. So far, China has survived all US attempts to destabilise it, having successfully deployed the Sun Tzu tactic of bending with the wind. But Sun Tzu also warned that there is no instance of a country having benefited from prolonged warfare. At some point and when the time is right, China must be prepared to take the initiative and inflict a final financial defeat on its aggressors. Perhaps the Basel 3 move will trigger the event for her by driving the dollar price of gold higher, destabilising the dollar.

Furthermore, China has always understood that relying on export surpluses to America to drive her economy was a transitory phase because of the likely kickback, which is what happened under President Trump.

As long-term thinkers and with their regular five-year plans the Chinese have consistently shown an objective of self-reliance. Following a transitory period based on the manufacture of cheap exports, the vision has been to develop a large non-agricultural middle class acting as a consumer base with her own infrastructure and technological development. And rather than depending on trade with a belligerent America, China’s natural trade partners are the nations of the Eurasian land mass.

It is to be expected that a growing middle class will reduce the nation’s overall propensity to save, and all else being equal China’s trade surplus would then diminish. Admittedly, a reducing trade balance is also dependent on the governments of China’s export markets keeping control over their budget deficits — a discipline sadly lacking in China’s largest trade counterparties.

Other than the trade position, the long-term vision is in sight, which means that the loose monetary policies that were central to getting to this point in China’s evolution are no longer necessary and are now being reined in.

When the Chinese observed the Fed going all-in on inflationary financing with zero interest rates and record QE last March, it did not take them long to respond. Their analysis would most probably have been that the dollar would rapidly lose purchasing power, undermining its credibility as the world’s reserve currency. It was something the Chinese have long wanted, seeking to replace the dollar for its own trade with the yuan. But the more immediate consideration is that China’s trade surplus with America will increase significantly, mirroring the US budget deficit as so-called savings are unwound, potentially leading to yet more trade friction.

March 2020, when the US stepped out on the road to hyperinflation, was therefore time for a change in China’s economic strategy. She has graduated towards an economy which, despite intended greater consumer spending, will remain savings-driven and characterised by a strong currency, like Germany and Japan were in the seventies and into the late nineties. A stronger yuan offsets some of the commodity price rises due to dollar weakness. A stronger yuan increases the standard of living and personal wealth of the blue-collar worker, and that will be vital if the Communist Party is to retain its customary control. Marginal export producers will suffer, but they can be encouraged to redeploy their capital resources towards serving domestic markets.

Western analysts in thrall to neo-Keynesian inflationism fail to understand what China is doing and have missed the point entirely. But as the US with its weakening dollar drifts further behind China, the geopolitical tensions will increase. And it is here that China must be considering how to play her trump card: the implementation of sound money policies so that the yuan becomes the trading currency of choice for all Asia, the Middle East and Africa. In the process, with respect to the ultimate sound money, gold, we will obtain answers (which we know in advance anyway) to the following questions:

  • Why did China delegate to the Peoples bank of China a free run between 1983 and 2002 to acquire gold and silver on behalf of the state before permitting the people to buy any?
  • Why did the state then run an advertising campaign on TV and elsewhere encouraging the population to buy gold?
  • Why did the state invest heavily in gold mining to the extent that China has become the largest gold mining nation by a country mile?
  • Why has the state retained a firm monopoly on all gold and silver refining?
  • Why does the state retain strict control over the vaulting system for bullion?
  • Why does the state retain control over the Shanghai Gold Exchange monopoly through the PBOC and not permit the establishment of rival exchanges?
  • Why does the state permit the import of gold and gold doré but bans all gold exports? (Chinese refined bars are hardly ever seen outside China — the only permitted exception is limited supplies to Hong Kong, most of which is turned into jewellery for sales-tax-evading day-tripping mainlanders) And,
  • Why has the state appeared to have set out to take control of the global market for physical bullion?
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Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not reflect those of Goldmoney, unless expressly stated. The article is for general information ...

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