Bank of China Ltd. (OTCBB: BACHY)recently became the first Chinese bank as a participant in the auction process of setting gold prices in London.
Now Industrial & Commercial Bank of China Ltd. (OTCBB: IDCBY) is considering joining the banks that make up the new London gold fix.
The new London gold fix is a recent overhaul for more transparency, but it’s interesting that Chinese banks are so intent on getting involved in the process.
China is now considered to be the number one consumer of gold out of all of the countries in the world. It’s no surprise that Chinese banks want to get in on the action in London, where over-the-counter gold trading can exceed $20 billion per day.
It’s also suspected that the Chinese central bank has vastly underreported its holdings of gold reserves. While many central banks have sold gold over the last couple of decades, the Chinese central bank has apparently been a big buyer, particularly in more recent years.
It seems that Chinese stocks and real estate are in a big bubble, and there are signs that they could fall quickly. Some believe that China’s gold consumption could go even higher with a major downturn in stocks, as investors seek safety for their investments.
However, it could just as easily go the other way too, as people look for liquidity in a time of recession or depression. China and the over 1.3 billion people that live there is really a different story from any other we have seen in history.
There has been major progress in China over the last 30 years. It’s like nothing this planet has ever seen. The Chinese also save a lot of money and invest a lot of money. Unfortunately, the central planners there have inflated the currency greatly and distorted the economy. So it is difficult to know how much of the rise in living standards is due to real wealth creation and how much of it is false prosperity.
China’s Economic Problems
We don’t know how China’s first official modern-day recession is going to play out. It probably won’t be pretty. We can be optimistic though and hope that the government and central bank there will take a step back when things spiral downward.
The Chinese government at this point is a tale of two cities. On the one hand, the central planners engage in massive monetary inflation and, well, central planning. They think they can run an economy of 1.3 billion people.
But on the other hand, Chinese officials often make more sense than what we hear in the U.S. or elsewhere. They understand the benefits of free trade, but they can’t abandon their mercantilist policies. They understand the importance of a stable currency, but they can’t stop inflating. They understand the importance of gold, yet they don’t use it to back their currency.
The Chinese government is supposedly trying to make the yuan a viable competitor for the dollar in world markets. Chinese officials are trying to persuade the IMF to include the yuan in its basket of reserve currencies.
Again though, the Chinese officials are trying to have things both ways. The yuan is not a freely floating currency. It cannot be openly bought and sold in world markets the way that the other major currencies can. How can you have a currency that is not freely floating as part of the IMF’s basket of currencies?
It would be so easy right now for the Chinese to threaten the U.S. dollar’s status as the world’s reserve currency. They could simply open up the yuan to the world markets and that would probably be enough to make it somewhat competitive.
Then it could actually stop inflating the currency in an attempt to subsidize its export industry.
If we really want to push it, imagine if the Chinese were to back the yuan with gold. You would see investment fly into China so fast, it might just make the country skip over the coming recession with barely anyone noticing.
With Chinese banks getting involved in the London gold fix, and with Chinese exchanges getting more involved in gold pricing and trading in yuan, there is an obvious trend here.
The Chinese central planners just need a little bit more of an education in free market economics and maybe we will see the yuan freed, or maybe even backed by gold. We shouldn’t hold our breath, but at least they are showing some interest in gold, which is at least a good start.