If China were to partially back its yuan with gold it would require a gold price of $64,000 per ounce, 50 times gold bullion’s price today, according to a recent article from respected Bloomberg Intelligence. It seems like an outlandish forecast.
However, as tensions between the United States and China continue to escalate such a scenario is not actually as implausible as it may first appear. If China were to back its yuan with gold it would require a price of $64,000 per ounce according to a recent report from Bloomberg.
While Bloomberg give no details as to how they arrive at this figure, our “back of envelope” calculations would confirm that at its current value relative to the dollar the yuan would indeed require gold – priced in dollars – to be priced in the tens of thousands of dollars.
Chinese M1 money supply is roughly 33.64 trillion yuan which at todays exchange rate equates to around $5.4 trillion.
Bloomberg conservatively estimate China’s gold reserves at around 3150 tonnes although many analysts believe the figure to be much higher. In order to back $5.4 trillion yuan with 3150 tonnes of gold, the gold price would need to be in the region of $48,600 per ounce.
Bloomberg conclude that, at today’s prices, it would be “basically impossible” for China to fully back its yuan with gold. Indeed, at $1,200 per ounce, it would require over 126,000 tonnes to back $5.4 trillion.
Bloomberg states that “there’s no evidence” that China seeks to adopt a traditional gold standard. However, China’s appetite for gold in recent years has been voracious and it is clear that they and the People’s Bank of China (PBOC) place great strategic importance on the precious metal.
The Chinese have been quite overt in recent months in their ambition to establish the yuan as a rival reserve currency and it is likely that they intend gold to play a role in that ambition. If China were to even partially back its currency with gold it would gain further favour across the world as a reliable reserve currency when viewed against the increasingly debased U.S. dollar. In order to maintain some semblance of credibility the United States would likely be forced to follow suit.
For the United States to back its gargantuan M1 with its stated, and almost certainly grossly overstated, gold reserves of 8,500 tonnes it would push gold prices to multiples of their current price.
There has been a definite heating of tone in the war of words between the United States and China in recent months. Only this morning, the Wall Street Journal reports on how details of 4 million federal employees were hacked in April. While the FBI have not directly accused China, the WSJ suggests that China is the prime suspect.
At the end of last month a Chinese state-controlled newspaper stated that if the United States continued to interfere with its activities in the South China Sea, war was “inevitable.” China are clearly not intimidated by the prospect of war with the U.S.
China rejects what it sees as U.S. “meddling” in South East Asia. At last years APEC conference, China’s president Xi had President Obama pointedly placed at the peripheries of the stage for the official photograph. President Putin was by his side. The message was subtle but quite clear – China views the United States as a peripheral nation in Southeast Asian affairs whereas Russia is at the centre.
If tensions continue to escalate – and with that the prospect of a “hot war” as recently warned of by many including George Soros – each side will seek to weaken its rival in a variety of ways. In January, Russia’s Prime Minister Medvedev stated that if his country were cut out of the SWIFT system, the “Russian response – economically and otherwise – will know no limits.”
In the event of an escalation in economic warfare it seems obvious that the achilles heal of the United States is the dollar and its erstwhile global reserve currency status. Many analysts believe that China would be reluctant to sink the dollar given it would undermine the value of their vast holdings of U.S. Treasuries and foreign exchange reserves.
However, there will be a tipping point where the advantage to be gained by badly impacting the dollar and positioning the yuan as new reserve currency will be greater than the disadvantage suffered by a collapse in the value of the dollar.
The tipping point is closer than many believe.