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Is China Backing the Yuan with Gold?

The Inconvenient Truth about a Gold-Backed Yuan

Written by Geoffrey Pike
Posted May 26, 2015 at 1:37PM

chchinagoldOver the last several years, there have been many stories about the rising Chinese economy and an increasing role for the Chinese currency on the world stage. Some have gone so far as to predict that the Chinese yuan will take over the U.S. dollar as the world’s reserve currency.

In addition, there is also speculation in the blogosphere that the Chinese are going to surprise the world with a gold-backed currency. The Chinese have been accumulating more gold over the last few years, and it is likely that the central bank has higher gold reserves than what is reported.

The Chinese government is attempting to get the yuan included in the IMF’s Special Drawing Right (SDR) currency basket, which includes the other major currencies of the world.

One of the major problems, despite the large Chinese economy, is that the yuan is not a freely floating currency. For this reason alone, it is not going to be a contender as a reserve currency. How could it be, if it is not openly traded?

As for the idea of a gold-backed yuan, Bloomberg ran a story last week pointing out that it would require an exchange rate of as much as $64,000 per ounce. With gold currently trading around $1,200, this seems highly unlikely. And if gold were to go anywhere close to $64,000 per ounce, then the world will have more important stories to deal with.

The Bloomberg story also stated the following: “Theoretically, to create an exchange rate of one ounce of gold for every $64,000, the country would need about 10,000 metric tons of the metal, they estimated. That’s nine times the nation’s official holdings and about 6 percent of all the bullion ever mined globally.”

In other words, there is no possible way the Chinese central bank could have a fully backed gold standard with the current yuan in circulation. It would require some sort of new currency to be issued, which in itself would create a lot of problems with all of the contracts and debt denominated in yuan.

Central Bank Inflation and Government Power

It is not quite clear how so many people are getting the idea that the Chinese government/ central bank is all of a sudden going to come up with an announcement that the yuan will be backed by gold.

Not only is it basically impossible right now, barring a massive monetary deflation, but it is also unrealistic. The Chinese central bank has engaged in huge monetary inflation over just the last decade alone. This is why there are huge bubbles in both Chinese real estate and Chinese stocks.

If the Chinese government/ central bank were on the verge of going to a gold standard, don’t you think it would at least stop its huge monetary inflation first?

In addition, the Chinese government keeps accumulating other reserves, including U.S. government debt. Its holdings of U.S. Treasuries increased by almost $40 billion in the last reported month. It now holds about $1.26 trillion in U.S. debt.

If the Chinese were moving towards a gold standard, the central bank would probably not be adding to its holdings of U.S. Treasuries. It would be using this money to buy up more gold for its reserves.

China has come a long way over the last 35 years. It is no longer a communist economy for the most part. There are still elements of socialism. There are a few elements of capitalism. It is mostly Keynesian central planning in China, which is certainly better than communist, but still with a lot of problems.

The Chinese politicians are not that economically savvy. They are mercantilists. They believe in propping up its export sector. This subsidizes American consumers and others at the expense of Chinese consumers.

China has a lot of problems because of its central planners. It is probably the biggest case of misallocated resources that this world has ever seen. This is why there are cities built for a million people that sit empty. It is why there are billion dollar highways and bridges that are barely used.

The Chinese economy is going to have its first modern day recession at some point. It is going to be bad. Eventually, it is likely that China will recover and the economy will see more growth, hopefully coupled with freer markets.

But this notion of a gold-backed yuan is nothing but fantasy at this point. It isn’t going to happen. Alan Greenspan said correctly in the 1960s – long before becoming Fed chair – that gold stands in the way of the statists and their inclination to spend money and issue debt.

There is no way that the Chinese central planners are going to voluntarily give up an enormous amount of power by going to some form of a gold standard. It would drastically reduce their ability to spend money. It would reduce their power. It would limit their ability (or lack of) to centrally plan the economy.

There will be no gold-backed yuan any time soon.

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