Is China preparing for a new global reserve currency?

By Filipe R. Costa

While most hedge funds have been heavy sellers of gold during the year, China has been happily accumulating as much as it can. They’ve been able to purchase a record amount of gold, without triggering a price increase, thanks to the Fed’s tapering threat, which made investors believe the central bank would soon reduce the money supply.  

Since September 2011, China has imported 2,816 gross tonnes of gold from Hong Kong, which adds to whatever was produced domestically. The pace of their purchases has increased over the last twelve months. In March alone, the country imported 223.5 tonnes of gold, which remains an all-time record. In August they bought 131.4 tonnes, which is the second highest amount.

Even after discounting for exports, China’s net increase in gold remains extremely high. Imports outpace exports by a multiple of four. By the end of August this year, China had imported 997 gross tonnes of gold, which translates into 741 net tonnes. At this pace, the country will accumulate 1,100 tonnes of gold by the end of the year.

To put these numbers into perspective, let’s take a look at the top 10 countries by gold reserves, as reported by the IMF in January 2013:

The United States tops the table with more than 8,100 tonnes of gold, more than double Germany’s reserves, which are the second highest on the list.

China appears in sixth position, but there are doubts about the true Chinese position. The country doesn’t release comprehensive and timely data about its gold reserves. The most recent figures from China date back to 2009, when their official holding of gold was 1,054.1 tonnes. Given that the country is believed to have imported 2,816 gross tonnes, since September 2011, the up to date figure is likely to be significantly larger.

Even after discounting for exports and assuming a ratio of 0.75 (net-to-gross imports), the net number of imported tonnes would be about 2,100. If we add these 2,100 tonnes to the 1,054 of officially recognised tonnes, the updated Chinese holding would be 3,154 tonnes.

However, even this figure does not account for net imports between early 2009 and late 2011. Let’s assume they imported between 500 and 1,500 tonnes during this period. Accepting these figures, then their total holding would now be between 3,654 tonnes and 4,654 tonnes. This would now put China as the second largest holder of gold, ahead of Germany.  

Another interesting aspect of the table above is the “% of reserves” column. This represents gold’s share as a proportion of a country’s foreign exchange reserves.  As you may have already noticed, the number for China is extremely low (though will probably be higher now). China is the country with the largest net total of foreign exchange reserves in the world. They currently hold about $3.5 trillion in assets. Of these foreign assets, China holds $1.3trillion of US Treasuries, well over 1/3 of the total holdings.  

This could prove to be a huge global problem in the future.

Concerns about the sustainability of US debt have been growing for several years. Many inside China are now questioning why the country holds such an enormous amount of dollar denominated assets. This has manifested itself recently in public comments by Chinese officials about their increasing discomfort at the fiscal state of America. They have even gone so far as to suggest a new international monetary system is required.

With China importing 1,000 tonnes of gold a year, we suspect they are betting on a dollar collapse and the introduction of a new asset back currency.

America’s political reaction to this has been incredibly myopic. US politicians conducted their debt debate as if this were an issue that just affected America. They are wrong!

China is already making a move to exchange US debt for gold and we expect others to follow. Under such circumstances we wouldn’t touch 10-year US debt at 2.7%, with a growing debt-to-GDP ratio already above 103%. Would you?