This week, based on indicators of improving Chinese manufacturing activity,
commodity and stock markets surged in the Pacific Rim. It appears that China's
recession-fighting policies are being judged successful. The 41% rally in
Chinese stocks in 2009 from the 2008 lows dwarfs the single-digit rallies in
the US and Europe. With Western economies still sluggish, eyes are turning
eastward for solutions to the global economic riddle. As such, recent hints at
the direction of Chinese monetary policy should be closely regarded.
At the recent Group of 20 London meetings, China called for a new international
monetary order with a gold link. This was followed by the sudden disclosure
that China had used part of its huge gold output to boost its own reserves by
some 600 metric tons, a 75% increase in total holdings since 2003. In his first
100
days in office, President Barack Obama's administration has injected nearly
US$40 billion each day into US economy. Given the inflationary impact that such
a torrent of new cash will spark, it is logical that the Chinese hedge its $1
trillion position with a more reliable store of value.
International money continues to flood towards the Chinese economic sphere,
leaving the "old" industrial economies of America and Europe out in the cold.
The cause is quite simple: the economies of America and China are mirror images
of each other. The China-centric countries are producer-dominated and America
is consumer-dominated. Over time, this dichotomy is producing massive shifts in
global wealth.
For a century, American administrations have relied on the inflationary powers
of paper money to finance consumer growth. The fact that the US dollar is the
world's reserve currency enabled this scheme to persist for longer than would
have been tolerated otherwise. The "stimulus and bailout agenda of George W
Bush and Obama is the same practice on overdrive. While driving the country
further into debt, it also ensures that it will be progressively less
competitive in the global economy.
China, on the other hand, is the world's largest producer and one of the top
three exporters, piling up vast current account surpluses, especially in US
dollars. In order not to boost its currency to levels that would make its
exports less competitive, China maintained its US dollar surpluses in dollars,
investing the bulk, almost $1 trillion, of them in US Treasuries. This acted as
"vendor financing" for its exports to America. The technique is similar to
television commercials that promise "make no payments for four years", except
in this case the deal is pushing 40 years.
To combat the global recession, China spent some $700 billion on a stimulus
package, primarily focused on infrastructure. As such spending adds more value
to the economy than government make-work programs, it now appears that China's
stimulus package is having positive results.
Increased economic activity in China will benefit American companies with
China-sourced sales. But the majority of the American economy remains oriented
toward the American consumer, and his ever-increasing ability to take on debt.
This is obviously not sustainable.
The outlook for America is for hyper-stagflation, or continued economic
recession accompanied by rapidly rising prices. This calls into question the
continued role of the US dollar as the world's reserve. Surplus nations,
particularly China, are voicing their growing concern. They are exploring
other, less volatile arrangements. They may be considering a return to the
bulwark of monetary stability: gold.
Now the world's largest gold producer, China would benefit tremendously from a
shift away from the US dollar and toward gold. She is clearly interested in
world leadership, but would never dream of challenging the US militarily.
However, in the 21st century, the weight of economics renders martial might
largely irrelevant. Still, she can't afford to act irresponsibly.
There are a few considerations that should temper her ambitions. Even with the
600 metric ton increase over the past five years, China's gold holdings amount
to only 1.6% of its total monetary reserves. Also, at 1,050 metric tons total,
China's holdings are still dwarfed by the 8,132 metric tons held by the US.
Nevertheless, the Chinese call for a new, gold-linked reserve currency,
combined with the near doubling of their own gold reserves, points to a major
strategic trend that can be expected to spread to other surplus nations. The
biggest winners, personal or governmental, will trade their dollars for gold
before there's a rush for the door.
Private investors can ride the wave created by China's strategic shift by
continuing to add to their gold positions.
John Browne is senior market strategist, Euro Pacific Capital. Euro
Pacific Capital commentary and market news is available at http://www.europac.net/">.
It has a free on-line investment newsletter.
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