When I put my orders in for gold and base metal mining shares yesterday, I hadn’t seen this Reuters report that a senior Chinese researcher had recommended buying gold instead of dollars for China’s reserves:
China should buy more gold because the U.S. dollar is poised for a fall and the metal is needed to support the greater international role envisaged for the yuan, a senior researcher with the ruling Communist Party said on Thursday.
Li Lianzhong, who heads the economic department of the Party’s policy research office, said China should use more of its $1.95 trillion in foreign exchange reserves to buy energy and natural resource assets.
Speaking at a foreign exchange and gold forum, Li also said that buying land in the United States was a better option for China than buying U.S. Treasury securities.
“Should we buy gold or U.S. Treasuries?” Li asked. “The U.S. is printing dollars on a massive scale, and in view of that trend, according to the laws of economics, there is no doubt that the dollar will fall. So gold should be a better choice.”
There is no suggestion that Li, even though he is a senior researcher, was enunciating an agreed party line.
However, a debate is swirling in China about how the country can reduce its exposure to the dollar and to U.S. assets in case America’s ultra-loose fiscal and monetary policy rekindles inflation and erodes the value of the dollar and U.S. Treasuries.
To that end, China has said it will buy up to $50 billion worth of bonds denominated in Special Drawing Rights, the International Monetary Fund’s unit of account, to be issued by the IMF.
Chinese companies, at Beijing’s bidding, are also snapping up energy and commodity supplies around the globe to fuel its fast-growing growing economy.
China disclosed on April 24 that it had increased its holdings of gold to 1,054 tons from 600 tons since 2003.
The Obama administration is likely to create a glut in the supply of dollars. As the economy comes down from the sugar high of federal spending, Obama’s impulse will be to spend more money. If he can’t produce an economic recovery during his first term, he probably will get only one term. He’s like a trader with a one-sided incentive, betting his career prospects with other people’s money. At the same time, Obama will reduce demand for dollars: by disrupting the rule of law in capital markets (through the rigged auto industry bailouts, tampering with mortgage collateral and so forth), Obama has eliminated a great deal of the incentive for foreigners to come to American capital markets, rather than, say, China’s.
As I’ve observed on numerous occasions, that portends big trouble for the dollar. But the trouble is not likely to emerge suddenly. The world has no alternative to the dollar for the time being, as my friend Prof. Reuven Brenner of McGill University points out, and America is lucky that this is the case. Robert Mundell, the world’s greatest international economist, argues that countries should use a basket of major currencies (dollar-euro-yen) and monitor the gold price as an indicator of prospective future inflation. Whether such a system ever might come into existence is hard to answer, but it is easy to state with certainty that it won’t happen soon.
Deflation is a stronger wind than most observers think, for demographic reasons: the aging world population wants to defer consumption in order to buy securities , that is, trade present goods for future goods. Like Japan in the 1990s, that is deflationary.
Nonetheless, one can’t keep swinging a sledge-hammer at the pilings of the American economy without consequences. The danger that the world may dive into alternatives to the dollar — hard assets of all sorts — is substantial, even if it isn’t immediate. (Then again, if Israel bombs Iran’s nuclear facilities and Iran closes the Straits of Hormuz, we could reach the long-term a lot quicker than we might have thought).
In the short term, China is going to do everything it can to keep the dollar strong. The last thing China wants is 1) to devalue its foreign exchange reserves and 2) to increase the cost of its goods in dollar terms. Its exports to the US are weak enough as matters stand. But China is going around the world bidding for whatever mining and energy assets it can buy, and is not dickering too much about price.
That is why I am seguing out of credit into hard assets (mainly shares of blue-chip mining and energy companies) on market dips. We are caught in powerful crosswinds and it is beyond my powers to guess which way we might tumble. Americans are likely to be a lot poorer over the next decade thanks to Obama, and it is time to start building up hedges now.
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