TOKYO – One of the worst-kept secrets in global central banking is the extent to which Chinese officials exchange dollars for gold.
Governor Yi Gang’s team at the People’s Bank of China doesn’t admit much. The PBOC need not do that, however, given the clear policy trajectory Chinese leader Xi Jinping has followed in recent years: internationalization of the yuan as the dollar’s main rival.
Xi’s stance has not changed so much, other governments are noticing that confidence in the global reserve currency is waning and that an alternative to the dollar is desperately needed.
Especially as the US debt soars above $30 trillion, inflation is at a 40-year high, the Federal Reserve is pushing the largest economy into recession, and a mob of incendiary Republicans threatens to play politics again with Washington’s debt limit.
Not surprisingly, central banks that once hoarded dollars are now buying gold at the fastest ever clip. In the July-September quarter, central banks more than quadrupled gold purchases from a year earlier, adding nearly 400 tonnes net to already sizable stocks.
These figures from the World Gold Council are not an anomaly. The wave of gold purchases year-to-date has already surpassed any 12-month period since 1967, leaving traders guessing who the real whales are here.
Calculators can confirm that about 90 tons of purchases can be traced to Turkey (31.2 tons), Uzbekistan (26.1 tons), India (17.5 tons) and other developing countries. The remaining 300 tons, it is widely believed, bear Chinese fingerprints.
Xi’s ambitions to increase the use of the yuan in trade and finance would receive a huge boost if Beijing made it fully convertible. Ditto for making the PBOC independent from Communist Party interference.
In the meantime, however, US officials are doing Xi’s job for him, as Washington takes the dollar’s “exorbitant privilege” for granted, as 1960s French finance minister Valéry Giscard d’Estaing put it.
You can go back decades, but the last four presidents all share the blame. George W. Bush, president from 2001 to 2009, blew up Washington’s budget surplus on a massive tax cut for the wealthy. He then launched a costly and credible war on terror.
Subsequently, Barack Obama (2009-2017) failed to treat the root causes of the Lehman Brothers crisis, instead treating the symptoms. It was under his watch that Republicans toyed with the government’s debt ceiling. In 2011, S&P Global Ratings ripped off Washington’s AAA rating.
The arrival of Donald Trump in 2017 brought about another tax cut that flipped the budget, one that dwarfed Bush’s. Trump’s trade war with China, meanwhile, undermined confidence in US leadership. His disapproval of Fed Chairman Jerome Powell to cut rates was followed by one of the world’s most incompetent Covid-19 responses, resulting in an unthinkable over a million deaths.
The arrival of Joe Biden in 2021 sparked another explosion in government spending. It added to an already chronic sovereign debt challenge and pumped money into an economy already hot amid supply chain turmoil. Biden has not worked fast enough to increase productivity to relieve the Fed of curbing inflation.
Fast forward 671 days and dollar sales are gaining momentum. To some extent, this reflects investors betting that the days of Fed rate hikes in 75 basis point intervals are over. Still, the warning signs of central banks rushing to buy gold are hard to ignore.
The yellow metal currently shines thanks to its nature that it is not “another country’s liability,” said Nikos Kavalis, general manager of precious metals consultancy Metals Focus. “We think central banks in general will remain net buyers” for the foreseeable future.
Part of this rationale reflects the difficult calculation of government debt now beginning to dawn on global markets. Economist Emre Tiftik of the Institute of International Finance notes that the global debt-to-GDP ratio – nearly 343% – is now 20 percentage points lower than its peak in the first quarter of 2021, “helped by strong growth and flattered by inflation”.
But, he says, “emerging market debt ratios continue to rise, particularly in the financial sector.”
Tiftik explains that inflation-adjusted global debt issuance is now at its multi-year low. But “as governments look to support growth and meet higher funding needs, there should be more sovereign issuance in 2023” at a time when currency devaluation “creates additional headwinds for borrowers, including in mature markets with US dollar debt. “
The bottom line, says Tiftik, is that the “global sovereign interest bill will rise rapidly,” particularly for sub-Saharan Africa, but also in EM Europe and Asia. This explains part of the reason why demand for gold is rising.
Whether the gold purchase by the central banks will go ahead remains a mystery. EY Parthenon economist Gregory Daco notes that it appears that the Powell Fed “recalibrated monetary policy at its November FOMC meeting by adopting a new ‘speed versus destination’ paradigm – signaling its intent to achieve a higher terminal fed funds rate while doing so in a slower manner. pace.”
Daco adds that “central banks’ determination to tighten monetary policy aggressively, coupled with the lagged effects of monetary policy on the economy, increases the likelihood of too tight a tightening.”
Christopher Waller, member of the board of directors of the US Fed, said last week: “We are not softening. Stop paying attention to the pace and start paying attention to where the end point will be. Until we get inflation down, that end point is still a way out.
In the meantime, Beijing had dumped US debt. Between the end of February and the end of September, China sold at least $121 billion worth of US government bonds. Those sales picked up around the time Vladimir Putin’s Russia invaded Ukraine.
Since July, Chinese imports of gold from Russia have increased sharply. In that month alone, gold transactions in China rose to about 50 times the level of a year earlier.
Admittedly, Beijing has been scaling back its dollar holdings on and off since 2018, when Trump launched his trade war. By the middle of the year, Chinese government bond stocks were the lowest since 2010.
That was a year after then-Chinese Premier Wen Jiabao said Beijing was “concerned about the safety of our assets” and urged Washington “to honor its words, remain a credible nation and ensure the safety of Chinese assets.” “.
Two years later, in 2011, S&P confirmed Wen’s deepest fears when it cut the US debt. That was in response to Republican lawmakers’ refusal to raise Washington’s statutory borrowing limit, putting it at risk of default.
As Republicans prepare to hold power in the House, there is talk of taking the debt ceiling hostage again. This burn-down tactic would make it difficult for the Biden administration to pay its bills. The consequences of a resulting default could dwarf the 2008 global crisis.
Fiscal debauchery, meanwhile, would leave Biden’s Treasury Secretary Janet Yellen little room for maneuver should another Covid variant emerge and wreak havoc on the economy. The resulting slowdown at a time of high inflation could spell doom for corporate earnings and US stock prices.
This dynamic would unfold at a time when the yuan comes into its own. According to the latest figures from the Bank for International Settlements, the yuan is the fifth most traded currency in the world. The Chinese currency has jumped from eighth to fifth place in just three years.
The PBOC is also miles ahead of the Fed in creating a central bank digital currency. During the Olympic Games in Beijing earlier this year, the e-yuan was used to a limited extent. It was a first for a major monetary authority, giving China a pioneering advantage in rewriting the future of money.
Still, Washington’s biggest fear now is that major monetary authorities will see a first-mover advantage in dumping dollars. The way the US applies the magic trick of huge and growing debt that doesn’t cause yields to skyrocket is Asian savings. Along with Japan and China, Asia’s top 10 holders sit on about $3.5 trillion in US IOUs, just as inflation is rising at its fastest rate in decades and political polarization is deepening.
Concerns over Fed policy are also of concern. Analysts at UBS write that “investors had mixed feelings about gold in 2022, in part due to the cross-currents of rising real rates and a strong dollar (bearish gold) versus high inflation and heightened macro uncertainty (bullish gold).” They expect the Fed to start cutting rates from 5.0% to 3.25% in 2023, pushing gold to 1,900 an ounce from about $1,740 now.
China’s supposed gold hoarding is at the expense of the dollar, suggesting that the momentum for using the yuan as a reserve currency is accelerating. Of course we have to look at the economic malaise in China this year. Xi’s growth-killing “zero Covid” lockdowns pushed GDP growth to its slowest pace in 30 years. That is extra pressure in a tight real estate market.
As even Chinese bull Ray Dalio, founder of hedge fund Bridgewater Associates points out, there is great “confusion” about whether Xi is easing — or doubling down on — his draconian Covid lockdowns.
As economist Tyran Kam of Fitch Ratings notes, “we expect the government to take further steps to stabilize the industry. However, policies aimed at supporting housing demand will remain measured and selective as the government avoids policies that could lead to house price reflation.
“The direction of the ‘zero-Covid’ policy and the timely delivery of pre-sold homes are also important factors for home buyer sentiment. Effective implementation of recently announced measures to support private developers is also important for liquidity.
Still, the longer-term trajectory for global currency markets remains negative for the dollar as China and other top treasury-holding powers switch to an asset John Maynard Keynes once dismissed as a “barbaric relic.” That relic is now flashing red alert for dollar bulls.
Follow William Pesek on Twitter at @WilliamPesek