Gold Watch China’s new gold standard?
Group Economics Macro & Financial Markets Research Georgette Boele, tel,+31 20 6297789
26 May 2015 • • • • •
There are suggestions that China may introduce a gold standard. Such an event would have a significant impact on the gold market,... ...but we consider such a move highly unlikely, as... ...it would imply serious policy limitations and is not consistent with China’s policy actions so far. In addition, we do not consider gold an appropriate asset to link the value of one’s currency to.
Arrival of a new gold standard?
Gold as % of FX + Gold reserves
Recently, Bloomberg Intelligence released a report “Why
%
would China Consider a Gold Standard?”. It argues that “a
1.5
gold standard would help China quickly establish yuan reserve status. The sheer amount of yuan is staggering. Making it freely convertible could destabilise it if the process is not
1.0
properly managed. China may opt for its currency to be backed in some form by gold. The yuan does not register as a
0.5
significant global reserve currency; hence the motivation that China would have to adopt a gold standard”. In this note we assess the likelihood of China adopting a gold standard.
0.0 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 China
What is a gold standard? Under the gold standard, the money supply of a country is backed by gold. A full-reserve gold standard exists when the country’s monetary authorities establish a credible link
Source: Bloomberg, In 2002 the PBoC increased its gold reserves. As the overall level of reserves was still relatively modest, this led to a significant rise in the portion of gold holdings. This contrasts to 2009, when the overall level of FX reserves was much larger, and a rise in the central bank’s gold holdings had a much more muted effect.
between the value of the currency and gold. In order to do so, they need to hold sufficient gold to convert the circulating representative money into gold at a fixed exchange rate. There are two forms of full-reserve gold standards: an international standard, such as Bretton Woods (see Box 1) was, and a domestic standard (the standard that China may opt for). In the case of a domestic full-reserve gold standard, the standard is only introduced by one country. What kind of gold standard may China consider? If China were to adopt a form of gold standard it will likely do this in the form of a domestic gold standard. What does this entail? In this system China could fix the yuan against a specific weight of pure gold. If this standard were introduced, China would have to buy significant amounts of gold. It already has gold in its foreign-exchange reserves, but the amount it currently owns would appear far too small to be a credible basis for a full-reserve (domestic) gold standard. The value of China’s gold reserves currently equals a mere 1% of base money. If China were to buy large amounts of gold, the gold price would certainly rise. The country would, presumably, also ban the export of gold. This would further increase the scarcity of gold on international markets.
Is it likely that China would do this? In short, we judge that it is very unlikely. For a start, any form of gold standard implies serious limitations for the room for manoeuvre for policymakers. In addition, gold is not a stable asset, nor is it the safe-haven asset it may have been in the past. What is more, adopting any form of gold standard is not in line with China’s currency strategy up to now. Limitations to any form of gold standard Under a strict gold standard growth of the money supply would be linked to growth of the gold supply. In the case of a domestic full-reserve gold standard, to increase the money supply, the country needs to increase its gold holdings. A sharp gold price rally could make it more difficult to increase the stock of gold and limit the supply of money. This could lead to an unwanted tightening of monetary conditions. Even though China as gold mining country has the advantage of having gold supply being more closely at hand, large increases in the gold supply could automatically lead to significant gains in the supply of money due to gold-money convertibility. This is turn, could lead to a too rapid increase in the money stock which could be inflationary. Moreover, there are costs involved
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Gold Watch - China’s new gold standard?
in storing gold to back up the money in circulation. In general,
below). If we take these three measures into account, gold is
interest earned on gold reserves is relatively low. In the case
not a stable “asset/currency” in our view.
that interest rates were to rise, opportunity costs for storing gold also increase.
We compare gold with the three most liquid currency pairs that include the top four reserve currencies (US dollar, euro,
Gold as % of Monetary base
Japanese yen and the pound sterling) on which the IMF
%
Special Drawing Rights basket is based. Is the value of gold relatively stable? We don’t think so. For a start, as the table
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above shows, gold has the highest 6-month volatility and the 2.0
largest difference between highs and lows. In addition, although daily turnover in gold loco London (gold bullion that is
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physically held in London) may be significant, the daily 1.0
average turnover in the three major currency pairs, gold average daily turnover is lagging far behind (see table above).
0.5 0.0 90
95
00
05
10
15
…and a significant increase in prices Index
China
700 Source: Bloomberg
600 500
Gold is not as stable as one would think…
400
It only makes sense for monetary authorities to link their
300
currency to gold if they believe gold to be a stable and liquid
200
asset. We don’t think it is.
100
We define an asset and/or currency to have a stable value if •
volatility is relatively low (we take the 6-month volatility)
•
liquidity in terms of daily turnover is high and
•
there is no strong appreciation or depreciation trend in the price denominated in various currencies.
average 10.6 10.8 9.3 20.1
99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 GOLD/CNY index GOLD/JPY index
GOLD/USD index GOLD/EUR index
Source: Bloomberg
…and its safe-haven status has been reduced significantly
The least stable asset since 1999… 6M Volatility EUR/USD USD/JPY GBP/USD Gold/USD
0
The gold market has dramatically changed with the arrival of high 22.9 25.5 23.1 44.0
low 5.1 5.9 5.4 10.7
gold products that opened the market to a wider public. Gold is not only bought as a protection for uncertain times but also for speculation. The latter goes completely against gold’s safehaven character and at times it more than overshadows it.
Source: Bloomberg
Gold price and outstanding ETF positions …with the lowest average daily turnover in bn USD…
Total ETF positions
Gold price
100
2,200
80
1,800
60
1,400
Average daily turnover in bn USD
Source
USD/EUR
1289
Triennial Central bank Survey FX Turnover April 2013
USD/JPY
978
Triennial Central bank Survey FX Turnover April 2013
USD/GBP
472
Triennial Central bank Survey FX Turnover April 2013
40
1,000
Gold
240
LBMA Loco London Liquidity survey Q1 2011
20
600
Source: BIS, LBMA
0
200 04 05 06 07 08 09 10 11 12 13 14 15
Moreover, gold prices have rallied between 300-500% since
Total ETF positions gold (lhs)
1999 depending on the currency denomination (see graph Source: Bloomberg
Gold price in USD per ounce (rhs)
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Gold Watch - China’s new gold standard?
For example, at the height of the global liquidity crisis (when
unlikely in our view that China would adopt a gold
there was a shortage of liquidity) gold prices dropped sharply
standard. It is true that gold as percentage in the total
because investors valued cash more than gold. This suggests
reserves is very low. China may increase the percentage of
that at times of severe crises, gold could not live up to its safe-
gold reserves to diversify its reserves. However, this would not
haven status. The graph above shows that the variation in the
be a move into the direction of adopting a new gold standard.
gold price has coincided with a buildup and liquidation of
Growth is currently of a higher priority than the reserve status
outstanding investor positions in gold. This is not a positive
of the yuan. Therefore, it is unlikely that China will introduce a
development for a safe-haven asset, because significant
form of a gold standard and push up gold prices by doing this.
investor activity could indicate that it is used for speculation rather than safe haven. If you were to buy gold for safe haven purpose you would invest in physical gold and not in a gold-
Box 1:
related product.
Bretton Woods The Bretton Woods system was the last internationally used
What is the most likely strategy China will take?
gold standard. Under this system, the dollar was linked to gold
China has expressed its wish for the yuan to have a more
and many countries fixed their exchange rates to the US dollar.
prominent role as world reserve currency. The suggestion that
Central banks could exchange dollar holdings into gold at the
they might introduce a gold standard must probably be seen
US Federal Reserve at an official exchange rate of USD 35 per
against the background of this ambition. Currently, the yuan is
ounce. On 15 August 1971, the US stopped the convertibility of
the fifth most traded currency world-wide behind the US dollar,
the US dollar to gold.
euro, Japanese yen and the pound sterling. In order to increase its presence, the yuan needs to become fully convertible and also needs to meet most of the characteristics
Box 2:
of world reserve currencies (see box 2). At the same time,
What are the drivers to become a world reserve currency?
China would welcome if the yuan is taken up in the IMF’s
A world reserve currency is a currency that is held in significant
Special Drawing Right basket this year; otherwise it may take
quantities by central banks and sovereign institutions. The
another 5 years. Being part of this basket is not pre-requisite of
currency should be widely used in global trade and in the
being reserve currency, but it is a tool to gain more
pricing of commodities. Moreover, capital markets of the
importance.
country that issues a world reserve currency should be welldeveloped and deep. The currency should be highly liquid.
Are gold reserves predominant for a world reserve
Markets should be deep enough to accommodate financial
currency role?
markets in periods of stress/crises. The central bank and
Although gold bulls and doomsayers will strongly disagree with
financial authorities should have strong credibility. Moreover,
us, gold reserves are not the crucial determinant for a currency
the country should have a strong and relatively stable
to become a world reserve currency in our view. Gold reserves
economy, political stability and its economic and political
in the US as a percentage of reserves (FX, gold and SDR
institutions should be considered to have strong governance.
reserves), as a percentage of GDP and as a percentage of the
Often, though not necessarily so, this is accompanied by
money supply have declined over the years. This means that
economic and political power and supported by military clout.
currently the largest reserve currency, the US dollar, is functioning on the above mentioned characteristics of liquidity, strength and stable economy rather than gold. In the case of the other world reserve currencies such as the euro, Japanese yen and pound sterling, there is also no significant relationship between gold reserves and their reserve currency status. So an increase in reserve currency status does not go hand in hand with higher gold reserves in percentage of the total. In conclusion Why would China adopt any form of a gold standard? By doing so it would limit the room for manoeuvre of its policymakers and possibly hamper economic growth. This makes it very
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Gold Watch - China’s new gold standard?
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