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A Collapsing Dollar and China's Monetary Strategy
A Collapsing Dollar and China's Monetary Strategy
Market Su
This article describes how China can escape the fate of a dollar collapse by
tying the yuan to gold. There is little doubt she has access to sufficient META LS
gold. Currently, her interest is to preserve the dollar, not destroy it,
because it is the principal means of Chinese foreign interests being G OZ
secured .
M ET AL 2 4 HR SE
Introduction
Get the latest Goldm
In last week’s Insight I examined the position of the US dollar, given the Fed’s
before everyone else, d
current monetary policies, and concluded that the Fed’s dollar is likely to become
valueless by the end of this year. The consequences for other major currencies — the Your Name
euro, yen and pound — are that they are likely to fall with the dollar. This is because
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they adopt the same monetary policies, the same macroeconomic fallacies, and
through the Bank for International Settlements, G7 and G20 meetings agree to SUBSCR
continue to be bound by common policies. While the intention is for all to survive by
working together, instead it ensures that they all sink together.
Latest In
The maverick nations are Russia and China. Russia is obviously working towards
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protecting her currency with gold — there is no controversy there. China’s position is
A collapsing dollar and Ch
more complex. Her leadership relies on the inflation of bank credit through state-
strategy
owned banks to finance her infrastructure plans as well as in financing the massive J U NE 2 5 , 2 0 2 0 • AL ASDAI R M A
uplift her non-financial private-sector economy has enjoyed since 1980. Yet, she has
made aggressive moves to ensure her population owns physical gold and has invested The crisis goes up a gear
in mine production, making her the largest national producer by far, while ensuring J U NE 18, 2 0 2 0 • AL ASDAI R M A
The most controversial aspect of my previous comments about China’s gold Market Report: Running in
ownership is about the level of undeclared bullion. But the strategy has always been J U NE 19 , 2 0 2 0 • AL ASDAI R M A
clear. In 1983 the Peoples Bank was given a monopolist mandate by the Communist
Party to manage the state’s acquisition of gold and silver, while private ownership
remained banned. This fitted in with the Peoples Bank’s monopoly of managing
foreign currency dealing, confirming that in 1983 at least, the leadership and its
Get Started with
advisors regarded both gold and silver as primarily money.
OPEN A HO
Nineteen years elapsed before the Peoples Bank opened the Shanghai Gold Exchange,
permitting members of the general public for the first time to buy and take delivery
of gold and silver. Following advertising campaigns, the market for 24 carat gold
jewellery exploded, and together with investment gold, since 2002 withdrawals from
the SGE’s vaults have been about 17,500 tonnes, admittedly not adjusted for scrap
resubmitted for refining. To be consistent with gold policies after the SGE opened for
business, those nineteen years must have been used by China to acquire significant
quantities of undeclared bullion. But other analysts assume that the public held some
gold illegally before 2002 as well, so about 17,000 tonnes net of scrap for private
ownership seems about right.
The opportunity for the state to build a bullion hoard before 2002 was there.
Following the bull market ,which culminated on 21 January 1980, gold entered a 19-
year bear market taking it from $850 on that afternoon’s fix to a low of $256.8 in
July 1999. But by January 2002, gold was still on the floor at under $280. And there
were substantial sellers: portfolio disinvestment by Swiss banks, the largest private
depositories at that time, left them holding virtually no gold. [i] Central banks and
official sources reduced their holdings of monetary gold by 3,450 tonnes, but more
importantly gold leasing by them supplied an estimated 10,000—16,000 tonnes into
the market (Veneroso, 2005).
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US policy was to rub out monetary history by denying gold as having any monetary
role and to be replaced by the Fed’s unbacked dollar as everyone’s reserve currency. A
new generation of Harvard-educated Arabs went with the neo-Keynesians, preferring
stocks to gold, the opposite of that of their forebears who disliked financial assets,
including foreigners’ currencies. But these were also the formative years for China’s
adoption of capitalism.
The Chinese leadership, having a high degree of control over its population, is given
to long-term planning in the form of five-year plans with longer-term underlying
objectives. It is inconceivable that these plans would have omitted a gold strategy,
particularly since regulations were put in place giving the Peoples Bank its mandate
to build national reserves.
Given all the foreign exchange dealings of the Peoples Bank, handling inward
investment in the eighties and growing exports in the nineties, it could easily have
accumulated 20,000 tonnes of gold at contemporary prices, representing
approximately 10% of foreign currency flows across the bank’s trading desks.
Traditional secrecy in gold markets would have provided cover. All the Peoples Bank
needed to do was acquire an average of 1,000 tonnes a year, which given the bullion
flows and market dynamics in gold’s great bear market would have been achievable
without attracting attention.
It is only on the basis of this understanding that we can apply a 20,000-tonne ball-
park figure to the unknowable. And since 2002, China continued to import gold in
addition to its growing mine supplies to ensure its population ended up with
significant quantities of gold as well. Whether intentioned or not, the leadership has
ensured large quantities of 24 carat gold are in public circulation, which is important
in the event that gold backing for China’s currency is implemented.
In the event of a general fiat currency collapse, many nations have sufficient gold to
operate a gold exchange standard, admittedly at higher gold prices than those that
prevail today. That is not the problem. In government, treasuries and central banks,
there are very few who understand economics proper, being sold entirely on neo-
Keynesian macroeconomics. Neo-Keynesian macroeconomics is a belief system
unfounded on reality and their Zeus, or Jupiter, is inflationism. Their lesser gods all
owe fealty to this one overriding directive. Before sound money can be introduced,
they must all be swept from their temples.
With all its gold, by monetising it China could kill off the dollar tomorrow.
Undoubtedly, this financially nuclear option has become a backdrop to her strategy in
the ongoing trade and financial war against America. But the idea that by using this
undoubted power over the dollar China gains a simple victory if through her actions
the dollar is destroyed understates a more complex situation. It is not in China’s
interest on many levels, not least because of her ownership of dollars is about $3.4
trillion, of which only $1.5 trillion is invested in Treasuries, agency, corporate and
short-term debt in the US. The balance is actively used in loan finance to China’s
commodity suppliers, those involved with the belt and road initiatives and other
states with which China desires to gain influence.
Destroy the dollar and China’s heft around the world is destroyed as well, because
only a small proportion of China’s loan-influence is in renminbi. In that sense, if the
dollar collapses America gains a geopolitical benefit over China, her means of
international influence being crippled. The Chinese leadership will be acutely aware
of the consequences of the dollar’s demise and therefore will do nothing to encourage
it. Indeed, if the dollar begins its collapse in the foreign exchanges, we could find
China increasingly calling out the Fed on its inflationary policies. But then the Fed’s
problem is and will continue to be an inability to stop its addiction to unlimited
inflationism.
It will require a return to gold backing — the nuclear option so far avoided. While the
cost will be writing off trillions of dollars and its means of securing overseas
influence, there will be a monetary vacuum to fill. And compensation will be found in
an increase in the value of China’s declared and undeclared bullion stocks, as well as
the enrichment of its gold-holding people.
• The state currency must be an accountable gold substitute; that is to say every unit
of currency expansion must be fully backed by gold at the fixed exchange rate.
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To these we can add an addendum, and that is to reform the banking system so that
there is no expansion of unbacked bank credit.
If the Chinese obeyed these rules to the letter, not only would their gold-backed
currency lead to a quantum leap in the progress of its own economy, but given
China’s undoubted economic power the yuan would become accepted as the foreign
currency of choice for most of the world and it would encourage other nations to
adopt similar gold exchange standards.
The proof is found in a nation of ten million which two hundred years ago in less
than a century dominated technology and international trade, saw its population
increase threefold as prosperity spread and life-expectancy increased, encouraged
other nations to adopt gold standards, and by 1914 had built over 80% of the world’s
shipping afloat. That small nation was the United Kingdom. Just think of the
potential if China repeated the exercise.
The money that people use for their current and deferred consumption is rightly their
affair, and not the state’s. This is why every time the state takes control of money
away from its people it eventually fails, and the monetary function returns to the
metals trusted by people through millennia. Today, we face no less than this
transformation, the return to the peoples’ money and the destruction of statist fiat
currencies.
Of the world’s significant economies, China appears best able to plan for monetary
reform. Even so, it will not be easy and requires the completion of the new capitalist
mindset courageously introduced by Deng Xiaoping. Instead, under President Xi
China has drifted away from Deng’s vision towards internal suppression and
increasing state control. He must recognise that central planning in China has had its
day and it is time to give his population its economic freedom.
If only he can recognise it, Xi’s vested interest now lies in that direction. It will not be
easy, and there is no certainty he will grasp the opportunity. But if he decides to do
so, it requires the following issues to be addressed.
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In its early stages a mercantilist approach can have obvious objectives, which leads to
national capital being deployed with effect. But being based on monetary expansion,
even then capital is misallocated through monetary distortion, which only becomes
obvious later. As a continuing state policy, it leads eventually to substantial
tribulations and inefficiencies, and China has had its share of these.
The error is to regard the state as capable of being fundamentally motivated by profit.
A misleading precedent for mercantilists was the East India Company, which ran
India as its fiefdom until the Indian Mutiny. But that was a company which was
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The expansion and subsequent contractions in bank credit created a destructive cycle
of bank lending, particularly following the 1844 Bank Charter Act in English law,
which set the subsequent international standard. This must be stopped. In the case of
China, most banking is provided by state-owned banks, so if the state is determined
to maintain a sound yuan it should present few difficulties in eliminating bank credit
expansion.
The provision of monetary capital must be backed by savings and it is for the market
to establish a balance between immediate consumption and its deferral. And here,
China is in the fortunate position of having a strong savings culture, unlike the US
and UK along with most members of the eurozone, where after allowing for
consumer credit saving hardly exists.
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Progressively increasing tax rates mitigate against the acquisition of wealth, and
China will need to reform its income tax regime to a flat tax rate. Since government
spending is under 15% of GDP, with a reasonable personal allowance a flat income
tax of 20% should allow for a balanced budget and other taxes to be eliminated over
time. State spending targeted to an eventual 10% rate of state spending relative to
GDP would allow the income tax rate to be reduced and held to a 15% rate and the
abolition of all other taxes.
Income tax should be applied at the same rate on all sources of income. To make
income from savings tax-free is a distortion of the market. Post-war Japan and
Germany made it easy to avoid tax on savings interest, and their economies became
savings driven and highly successful. But in China’s case, where a very high savings
rate already exists, not only is such a policy unnecessary, but it leads to unwelcome
imbalances in foreign trade which so long as other fiat currencies exist are politically
destabilising in the longer term.
Digital money
China is almost certain to be tempted to adopt a centralised cryptocurrency approach,
a forerunner of which is reportedly in trials at the moment. It is thought by many
that application of this technology may well find a place in a new form of gold
substitute.
Other commentators suspect that China’s motivation is to maintain control over its
citizens’ spending. If this is the case it would be a mistake, and at odds with an
objective to maximise the nation’s economic potential for the benefit of its citizens by
returning to free markets. However, state-issued crypto technology is too young at
this stage to be relevant to the successful establishment of a gold substitute currency.
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be addressed, more likely during a monetary crisis when political objectives can be
radically changed, than at any other time.
Otherwise, China has sufficient bullion reserves and gold ownership is widespread in
the population. Silver, which is more naturally the money of the people is also widely
available for coinage. Furthermore, there is reason to hope that the state is not as
beholden to the neo-Keynesian macroeconomic inflationism as are other leading
nations.
To be successful in defending the yuan from the gathering global monetary crisis,
when the decision is taken to go ahead the following announcements should be
immediately made.
2. Following the defining date the quantity of yuan in circulation will be set by
market demand, and any increase in the quantity will be fully backed by gold reserves
held and allocated for that purpose by the Peoples Bank.
3. The announcement will also state that conversion terms will be offered for all
government debt (currently about 40 trillion yuan) into a new perpetual loan,
interest payable at the holders’ choice in yuan or gold at the yuan/gold fixed rate,
which will be set at the defining date.
4. All holders of yuan will be free to exchange their yuan for new gold coin at the rate
set on the defining date. In due course silver coins at sterling proof will also be issued
as circulating currency, the rate set designed to ensure their continued circulation.
6. China’s withdrawal from all international cooperation at G7, G20 meetings etc.,
currency and economic management being no longer appropriate.
The markets can then set a gold exchange rate which will be adopted as the fixed rate
of exchange for the yuan. The return of a monetary function to silver is likely to
reduce the gold/silver ratio to 20 or perhaps less, and allowance should be made for a
settled relationship between gold and silver that might take a little longer to establish
on a lasting basis. Only then can silver coins return to circulation
There can be little doubt that a move to a gold yuan will have a profound effect on
remaining fiat currencies. As noted above, a short period of time between announcing
these plans and their implementation will be required for markets to adjust. It is
likely that fiat currencies would face downward pressure on their purchasing power,
and China must be seen to be protecting her own interests by returning to sound
money and not deliberately undermining the dollar.
The consolidated perpetual loan has many advantages. It never has to be repaid. The
coupon, reflecting gold’s rate of interest as well as issuer risk, could be set, at say 2%,
and the conversion price set at 50 per notional 100 gold-yuan of the bond. Those
prepared to back the Chinese government and its sound money regime would be
rewarded for the risk by a running yield of 4%. As the government’s rating improves
with the success of the return to gold, the price would rise towards par, giving early
investors a solid reward. The wealth creation for holders becomes a solid contribution
to providing capital for a progressing economy.
Other nations, particularly those in Asia, are likely to follow China in implementing
their own gold exchange standards, and all nations will be then faced with a stark
choice: do they hang on to their welfare states and their growing difficulties in
financing them, or do they stabilise their currencies? If China does adopt a proper
gold exchange standard, she would neutralise all America’s geopolitical power,
whether America follows suit or not.
And finally, China should cease to provide the statistics beloved of neo-Keynesian
macroeconomists, for they only serve to provide reasons for state intervention.
[i] Source: Gold Wars —The Battle Against Sound Money as seen from a Swiss
Perspective: Ferdinand Lips pp. 116
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T h e v iew s a n d opin ion s ex pr essed in t h is a r t ic le a r e t h ose of t h e a u t h or (s) a n d do n ot r eflec t t h ose of G oldm on ey , u n less ex pr essly
st a t ed. T h e a r t ic le is for g en er a l in for m a t ion pu r poses on ly a n d does n ot c on st it u t e eit h er G oldm on ey or t h e a u t h or (s) pr ov idin g y ou
w it h ou t fir st seek in g in depen den t pr ofession a l a dv ic e. C a r e h a s been t a k en t o en su r e t h a t t h e in for m a t ion in t h e a r t ic le is r elia ble;
h ow ev er , G oldm on ey does n ot r epr esen t t h a t it is a c c u r a t e, c om plet e, u p-t o-da t e a n d/or t o be t a k en a s a n in dic a t ion of fu t u r e r esu lt s
a n d it sh ou ld n ot be r elied u pon a s su c h . G oldm on ey w ill n ot be h eld r espon sible for a n y c la im , loss, da m a g e, or in c on v en ien c e
c a u sed a s a r esu lt of a n y in for m a t ion or opin ion c on t a in ed in t h is a r t ic le a n d a n y a c t ion t a k en a s a r esu lt of t h e opin ion s a n d
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