For years, hard-money enthusiasts (and critics of the Fed) have been wondering why a major world power doesn’t back its own currency with gold (or a broader collection of commodities), in order to unseat the US dollar as the world reserve currency. Part of the problem with such a strategy is that some of the best candidates are sitting on huge holdings of dollar-denominated assets–especially China and Japan, each holding more than $1 trillion worth of US Treasury securities. Even so, speculation that China may be acquiring gold for just this purpose are now so mainstream that even CNBC is reporting the story.
Last month, an article by Dhara Ranasinghe summarized a report put out Lombard Street Research:
“The massive flow of gold into the country does make it seem plausible that they [China’s authorities] could be moving in the direction of using gold in the effort to internationalize the currency and escape what is seen as a domineering dollar,” Lombard economist Freya Beamish said in a note…
In fact, latest official data shows that China imported and produced more gold last year than its consumers bought, fueling speculation that the authorities took last year’s dive in the price of gold to build up holdings of the precious metal…
The yuan…has steadily been appreciating since it was unpegged from the greenback in 2005 and had strengthened about 25 percent since then.
In recent years, the yuan has gained ground as a global currency as Beijing eases its control of the yuan – also known as the renminbi – and opens up China’s financial markets to foreign investors.
I have often warned that if the US dollar collapses in the foreign exchange markets, it could be sudden, rather than a slow-motion train wreck over the course of a few years. As I said in the beginning of this post, the situation is one where major players recognize that the dollar has a weak future, but don’t want to spook international markets by taking aggressive action. (It would be as if Bill Gates suddenly became bearish on Microsoft; he couldn’t unload half of his personal stock holdings without crashing its price.)
When people ask me what kind of scenario could break us out of this unstable equilibrium, I say: Well, I’m not predicting that this will be how it goes down, but one possibility is that a Chinese finance minister says his government is slowing the rate of Treasury purchases, and that gets mistranslated as a statement that they are halting them outright. (Note that according to this Treasury data, China’s holdings of US Treasuries in January were actually down 3% since November; we’ll have to see if this trend holds up.) This mistranslation then sets in motion of chain reaction where everybody tries to dump dollar-denominated assets since everybody is dumping dollar-denominated assets.
As more and more mainstream outlets begin frankly discussing the demotion of the US dollar from its position as world reserve currency, this unstable equilibrium becomes ever more precarious.