TOKYO — One of the worst-kept secrets in global central banking is the extent to which Chinese officials are swapping dollars for gold.
Governor Yi Gang’s team at the People’s Bank of China isn’t admitting as much. The PBOC doesn’t have to, though, given the clear policy trajectory Chinese leader Xi Jinping has pursued in recent years: internationalizing of the yuan as the top rival to the dollar.
Xi’s position hasn’t changed so much as other governments are catching on that trust is waning in the global reserve currency and an alternative to the dollar is badly needed.
Particularly as the US national debt zooms past $30 trillion, inflation is at 40-year highs, the Federal Reserve is pushing the biggest economy into recession and a band of firebrand Republicans threatens to play politics with Washington’s debt limit again.
Not surprisingly, central banks that once hoarded dollars are buying gold at the fastest clip on record. In the July-September quarter, central banks more than quadrupled gold purchases from a year earlier — adding nearly a net 400 tons to already sizable stockpiles.
These figures from the World Gold Council are no aberration. The year-to-date flurry of gold buying already well surpasses any 12-month period since 1967. This has traders guessing who the real whales are here.
Punters doing the math can confirm that about 90 tons worth of purchases can be traced to Turkey (31.2 tons), Uzbekistan (26.1 tons), India (17.5 tons) and other developing nations. The other 300 tons, it’s widely assumed, bear Chinese fingerprints.
Xi’s ambitions to increase the yuan’s use in trade and finance would get a huge boost if Beijing made it fully convertible. Ditto for giving the PBOC independence from communist party meddling.
In the interim, though, US officials are doing Xi’s work for him as Washington takes for granted the dollar’s “exorbitant privilege,” as 1960s French Finance Minister Valéry Giscard d’Estaing put it.
One can connect dots back decades, but the last four presidents all share in the blame. George W Bush, president from 2001 to 2009, blew Washington’s budget surplus on a giant tax cut for the wealthy. Then he launched a costly and credibility-slamming war on terror.
Next, Barack Obama (2009-2017) failed to treat the underlying causes of the Lehman Brothers crisis, tending to the symptoms instead. It was on his watch that Republicans played around with the government’s debt ceiling. In 2011, S&P Global Ratings yanked away Washington’s AAA credit rating.
Donald Trump’s arrival in 2017 saw another budget-busting tax cut, one that dwarfed Bush’s. Trump’s China trade war, meanwhile, undermined trust in US leadership. His browsing of Fed chairman Jerome Powell into cutting rates was followed by one of the world’s most incompetent Covid-19 responses, resulting in an unthinkable one million-plus deaths.
Joe Biden’s arrival in 2021 saw a fresh explosion of government spending. It added to an already chronic public debt challenge and pumped money into an economy already running hot amid supply chain turmoil. Biden hasn’t worked fast enough to increase productivity to take the onus off the Fed to curb inflation.
Fast forward 671 days and dollar selling is picking up speed. To some extent, this reflects investors betting that the days of the Fed’s hiking of rates in 75 basis-point intervals are over. Yet the warning signs from central banks racing to buy gold are hard to ignore.
The yellow metal is shining at the moment thanks to its nature of not being “another nation’s liability,” says Nikos Kavalis, managing director at precious metals consultancy Metals Focus. “We think overall central banks will remain net buyers” for the foreseeable future.
Some of this rationale reflects the difficult public debt calculus now dawning on global markets. Economist Emre Tiftik at the Institute of International Finance notes that the global debt-to-GDP ratio — near 343% — is now 20 percentage points lower than its peak in Q1 2021, “helped by strong growth and flattered by inflation.”
However, he says, “the emerging market debt-to-GDP ratio continues to rise, notably in the financial sector.”
Tiftik explains that global debt issuance adjusted for inflation is now at multi-year lows. Yet “as governments look to support growth and meet higher funding needs, 2023 should see more sovereign issuance” at a time when currency depreciation is “creating additional headwinds for borrowers, including in mature markets with US dollar liabilities.”
Bottom line, Tiftik says, the “global sovereign interest bill is set to increase rapidly,” notably for sub-Saharan Africa but also in EM Europe and Asia. This explains some of why demand for gold is surging.
Whether central banks’ gold buying continues remains anyone’s guess. Economist Gregory Daco at EY Parthenon notes that it appears the Powell Fed “recalibrated monetary policy at the November FOMC meeting by adopting a new ‘speed versus destination’ paradigm – indicating an intention to reach a higher terminal fed funds rate while doing so at a slower peace.”
Daco adds that “central banks’ determination in tightening monetary policy aggressively along with the lagged effects of monetary policy on the economy increases the odds of an overtightening.”
US Fed Board of Governors member Christopher Waller said last week, “we’re not softening. Quit paying attention to the pace and start paying attention to where the endpoint is going to be. Until we get inflation down, that endpoint is still a way out there.”
In the interim, Beijing had been dumping US debt. Between the end of February and the end of September, China sold at least $121 billion of US Treasuries. That selling intensified around the time Vladimir Putin’s Russia invaded Ukraine.
Since July, China’s imports of gold from Russia have increased sharply. That month alone, China’s gold transactions surged to roughly 50 times the year-earlier level.
Granted, Beijing has been pruning its dollar holdings on and off since 2018, when Trump launched his trade war. At mid-year, China’s Treasuries stockpile was the lowest since 2010.
That was a year after then-Chinese premier Wen Jiabao said Beijing was “concerned about the safety of our assets” and urged Washington “to honor its words, stay a credible nation and ensure the safety of Chinese assets.”
Two years later, in 2011, S&P confirmed Wen’s darkest fears when it downgraded US government debt. That was in response to Republican lawmakers refusing to raise Washington’s statutory borrowing limit, risking default.
Now, as Republicans prepare to hold power in the House, there is chatter about holding the debt ceiling hosting again. This burn-it-all-down tactic would make it hard for Biden’s government to pay its bills. Fallout from a resulting default could dwarf the 2008 global crisis.
Fiscal profligacy, meanwhile, would leave Biden’s Treasury Secretary Janet Yellen little latitude if another Covid variant emerges and slams the economy. The resulting slowdown at a time of elevated inflation could spell doom for corporate profits and US stock prices.
This dynamic would unfold at a moment when the yuan is coming into its own. The latest figures from the Bank for International Settlements rank the yuan as the world’s fifth-most traded currency. China’s currency leapfrogged to fifth place from eighth in just three years.
The PBOC also is miles ahead of the Fed in creating a central bank digital currency. During the Beijing Olympics earlier this year, the e-yuan was used in limited fashion. It was a first for a major monetary authority, giving China a first-mover advantage in rewriting the future of money.
Yet Washington’s biggest fear now is that major monetary authorities will see a first-mover advantage to dump dollars. The way the US pulls off the magic trick of a massive and growing debt not causing yields to skyrocket is Asian savings. Along with Japan and China, Asia’s top 10 holders are sitting on about $3.5 trillion of US IOUs just as inflation surges the most in decades and political polarization deepens.
Fed policy turmoil also matters. Analysts at UBS write that “investors have had mixed feelings towards gold in 2022, in part due to the crosscurrents of rising real rates and a strong dollar (bearish gold) versus high inflation and elevated macro uncertainty (bullish gold).” They expect the Fed to begin cutting rates in 2023 from 5.0% to 3.25%, driving gold up to 1,900 an ounce from about $1,740 now.
China’s assumed gold hoarding comes at the dollar’s expense, suggesting the momentum for the yuan’s use as a reserve currency is accelerating. Of course, China’s economic stumble this year bears watching. Xi’s growth-killing “zero Covid” lockdowns pushed GDP growth to the slowest pace in 30 years. That’s added pressure on a cratering property market.
As even China bull Ray Dalio, founder of hedge fund Bridgewater Associates, notes, there’s great “confusion” over whether Xi is easing up on his draconian Covid lockdowns — or doubling down.
As economist Tyran Kam at Fitch Ratings notes, “we expect the government to take further steps to stabilize the sector. However, policies aimed at supporting home demand will remain measured and selective, as the government avoids policies that could lead to home-price reflation.
“The direction of the ‘zero-Covid’ policy and timely delivery of pre-sold homes are also key factors to homebuyers’ sentiment. Effective implementation of recently announced measures to support private developers is also important for liquidity.”
Yet the longer-term trajectory for global currency markets remains dollar-negative as China and other top Treasuries-holding powers switch into an asset John Maynard Keynes once dismissed as a “barbaric relic.” That relic is now flashing red alert for dollar bulls.
Follow William Pesek on Twitter at @WilliamPesek