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China Continues to Hoard Gold

Why does China Keep Buying Gold?

Written by Geoffrey Pike
Posted October 18, 2015

handgoldThe People’s Bank of China (PBOC) reported its latest gold holdings, showing a nearly 1 percent increase in the month of September. Gold reserves rose by 14.9 tonnes to a total of 1,708.5 tonnes.

For the sake of comparison, the Federal Reserve reports gold reserves at over 8,000 tonnes, but this makes up the large majority of total reserves for the United States. This is also under the assumption that the Fed actually has all of this gold and that it has not secretly sold any of it or leased it out.

China on the other hand has over $3.5 trillion in foreign exchange reserves. Gold makes up only 1.7 percent of China’s total reserves, as foreign currency – particularly U.S. dollars and euro – dominate its holdings.

China has been reportedly reducing its foreign exchange reserves in an attempt to stabilize the yuan. This has been happening since its announcement to devalue the yuan.

Still, the latest report is out detailing the major foreign holders of U.S. Treasury securities. As of August, China is still the top holder, just above Japan. China’s holdings are right about where they were one year ago. So while China is not accumulating more U.S. government debt, it seems it is rolling over its maturing debt to keep its holdings steady.

While China is experiencing some major economic problems due to a previously inflated stock market and real estate market, it is not expected that the PBOC is going to stop increasing its gold holdings. We can’t know for sure, as the situation could change if the economy there gets even worse, but as of right now, the Chinese central bank is a net buyer of gold.

This is helping to put a floor under the price of gold. It is probably no coincidence that gold has performed much better than silver as an investment in recent times. Perhaps this is just due to silver being more volatile overall than gold, but it is hard to discount the fact that central banks buy gold. You don’t hear about central bank silver reserves because there are none.

Central Bank Reserves

The 1980s and 1990s were not good for gold or most precious metals. You would have been much better off in stocks and bonds during this time. This was also a time when there was little interest in expanding gold reserves by central banks.

In fact, some central banks were actually selling off their reserves. The culmination of this was Gordon Brown selling about half of the U.K.s gold reserves in the early 2000s. This was at a time when gold was selling for under $300 per ounce. His lack of financial wisdom did not prevent the people from electing him to become the prime minister.

But with the rise of China (even if some of its growth is false prosperity), and with the monetary inflation of the central banks, some central banks are realizing the importance of holding gold reserves.

Perhaps it is ironic that the inflationary policies of central banks around the world are the very policies that are leading central banks to increase gold reserves. Part of it may be because they don’t trust foreign currencies as much. Part of it may be that they don’t trust their own currencies as much.

In 2011, then-Congressman Ron Paul asked Fed Chair Ben Bernanke why central banks hold gold. Bernanke said it is a form of reserves. Congressman Paul then asked, “well why don’t they hold diamonds?” Bernanke’s answer: “tradition”. You could say that Bernanke was somewhat correct, but this really fails to get at the heart of the matter.

Central banks hold gold so that the people don’t lose trust in the currency. Even though there are no longer any major currencies backed by gold, they can still rely on gold reserves as something of an artificial backing.

Bernanke was not going to discuss any of this because he does not want to admit that the U.S. dollar – and every other fiat currency – relies on the trust of the people. If everyone lost trust in the dollar overnight, it would become worthless and the Fed would lose its power.

You could say the same thing about gold. If everyone decided overnight that gold is worthless, that is what it would become. But this is not likely to happen because of its history. Maybe you could say it is because of its “tradition”. Of course, you can’t produce more gold on a printing press or a computer screen as you can with dollars.

Chinese officials may be a bunch of Keynesian bureaucrats, but at least they know enough to be adding gold to its reserves. Even if things get worse in China economically speaking, it will be just as important for the Chinese to maintain some sense of confidence. This is what gold reserves can do for them.

The gold price has been holding up lately. If we hit a recession, the price could fall. But it is actually a fairly low-risk investment at this point, especially compared to most other things. If anything, the Chinese central bank will come in and buy more if the price goes lower. There seems to be a floor that the PBOC is providing.

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