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Felix Imonti

Felix Imonti

The author studied international relations and economics at UCLA where he was in the African Studies Program.  After graduation, he was a securities broker for…

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China Leads From The Shadows

China Leads From The Shadows

While the West tries to preserve the power and the glory of another time, the people with the plans and the determination to reshape the world are in Beijing and Moscow.

It has been a gradual, cautious journey from obscurity to the second most important currency in the world. The Chinese yuan achieved that standing at the end of 2013.

According to the Society for Worldwide Interbank Financial Telecommunication, the yuan held an 8.66 percent share of letters of credit and collections in October, compared with 6.64 percent for the euro. China, Hong Kong, Singapore, Germany and Australia were the top users of yuan in trade finance.

The milestone achievement was followed in March with the Chinese agreeing to the establishment of clearing banks in London and Frankfort to make trade in yuan a normal part of international commerce. These new facilities expand the trading of the yuan beyond Shanghai and Hong Kong and indicate a careful selection of the expanding role of the currency.

London is a major financial center and accounts for 62 percent of foreign exchange trade. Germany is the fourth largest economy in the world and an important trading partner.

The journey to the heights began in 2005 when the People’s Bank of China (PBOC) began a controlled float of the yuan against the U.S. dollar. Over nine years, the yuan has appreciated about 35 percent.

At the beginning of its development, China had adopted a model employed by Japan, South Korea, and Taiwan to promote rapid economic growth. The three models had used international trade, especially with the United States, to provide markets for goods at the lower end of the manufacturing sector. It required a plentiful, low cost labor force for labor-intensive manufacturing and an underpriced currency.

By 2005, the first phase of the rapid economic expansion had been achieved. Low-cost, unskilled labor producing cheap goods was being replaced by higher paid, skilled workers who were moving steadily up the economic ladder by producing higher quality goods.

An undervalued currency was creating inflationary pressure internally and diplomatic strains internationally. The float was intended to reduce both problems. What developed was the secondary effect of creating the beginnings of a yuan bloc with Singapore, Thailand, Malaysia, and the Philippines tying their currencies with a soft peg to the yuan. The peg was hardened in 2009 and South Korea as well as Indonesia joined the bloc.

The informal grouping was not dictated by Beijing. It was simply the recognition by the members that their trade relations with China were more important than relations with the United States. By having their currencies moving at the same rate as the yuan against the dollar, one factor of uncertainty has been removed from the trade.

At the same time, the dollar remains, for the bloc members, the currency in which international loans and other financial arrangements are transacted. Unlike the U.S. dollar, in which 87 percent of trade is financed, or the pound, the euro, the Swiss franc, and the Canadian dollar, the yuan lacks the liquid government bond market that is essential to enable it to be used as a reserve currency. It is the only one of the largest six economies that does not qualify as a reserve currency.

Since mid-2010, the Renminbi trade settlement scheme introduced currency swaps with some 23 trading partners from Iceland to Japan. Because of the steady appreciation of the yuan, foreign buyers have been reluctant to buy in the Chinese currency that will cost more in the future. Only 17 percent of trade has switched to the yuan.

The arrangement is the closest that the PBOC has come officially to the establishment of a reserve currency, but it may no longer be up to the PBOC to decide. Forty various central banks have begun holding yuan, and by doing so, creating a reserve currency even before China has allowed it to float freely.

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Jukka Pihlman, formerly with the International Monetary Fund and currently Standard Charterer’s global head of central banks and sovereign wealth funds, explained, "Central banks and sovereign funds have special treatment. They have the ability to invest in a way that any other investor does not have. When it comes to convertibility, there is nothing formally out there, but it is fully convertible."

Private speculators discovered the yuan long before the central banks decided to begin to hold it. Once the PBOC began the controlled float in 2005, holding the yuan was a guaranteed profit for the speculators. They could borrow yen during the time that it was the focus of the carry trade, or the U.S. dollar that was on a stealth depreciation as a result of the quantitative easing program.

The success of the yuan was also its weakness. The hording of offshore yuan meant that it was unavailable for commercial use. As the time to expand the use of yuan in international commerce by opening new clearing banks in London and in Frankfort approached, the PBOC had to break the hold of the speculators by demonstrating that holding the currency was no longer a guaranteed profit. That came in February and in March when the PBOC drove down the currency and broadened the trading bands from one to two percent. Since then, the yuan has lost 4 percent against the U.S. dollar.

These various steps are an indication that a new phase in the internationalization of the yuan has begun. A warning was given in 2011 by Xu Hongcai, a department deputy director at the China Center for International Economic Exchanges, that the world had fallen into a “dollar trap” that was unstable and unjust. Although his published paper was not a government policy position, his warning must be taken seriously that China is not satisfied with the status quo. The China Center is a premier Chinese think tank that is instrumental in shaping government policies.

China's central bank governor, Zhou Xiaochuan, proposed in March 2009 the establishment of a super-currency to replace the U.S. dollar as the world reserve currency. Justin Yifu Lin, the former chief economist of the World Bank, supports the idea of a super-currency, but adds the caveat that expanding a system along the lines of the Special Drawing Rights of the IMF will not achieve the objective of stabilizing the world economy. Neither is replacing the U.S. dollar with the yuan the solution.

While the idea of a super-currency has its advocates, no one has found a formula that will make it happen. The idea of basing the collection of currencies upon one particular currency simply circles back to what the Chinese view as a failed system. What is needed is a mechanism that functions without the involvement of a particular government. The October 2013 government shut-down in Washington when the debt limit could not be raised was a reminder that one government has too much influence.

Professor Li Yining of Peking University may have given a clue about the direction that China will follow in resolving what has become within the Chinese leadership a pressing issue when he addressed the Chinese People's Political Consultative Conference in 2011. Li Yining, who is known as Mr. Stock Market, is viewed as the architect of the current Chinese economic development with his proposal in 1990 that state-owned industries should be privatized and traded on a stock exchange where the public could participate in the growth of the economy. Many of his former students, such as Premier Li Keqiang, hold high positions in the government and continue to look to their former 84-year-old professor for advice.

He advocated that China should diversify the foreign reserves being held by the PBOC by acquiring foreign businesses, mines, and property in order to increase the returns on the vast pool of capital. He proposed that gold should be accumulated. "China should increase its gold reserves appropriately, and China must take every chance to buy, especially when gold prices fall," Li was quoted by the official Xinhua news agency as saying.

The PBOC reported to the IMF in 2009 that it was holding 1,054 tons of gold. Prior to the announcement, the State Administration for Foreign Exchange (SAFE), an agency of the PBOC, transferred gold to the parent organization, which recorded the gold as a part of its holdings.

The SAFE is serving as a gold acquirer for the central bank. It can hold the gold on its records or on the records of the bullion banks or other government agencies. By scattering holdings through a number of depositories, the PBOC is able to conceal its actual holdings. Dispersing purchases through various bullion banks and other offshore agencies, the SAFE conceals the quantities being added to its inventory.

Gold enters China through Shanghai, Shenzhen, and Hong Kong, with Hong Kong the main conduit. There is an indication that Beijing is to become a fourth port of entry.

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Most of the figures released about gold consumption in China are based upon Hong Kong figures that are more transparent than those provided by Chinese sources. Using the Hong Kong statistics as the guideline, figures released in January indicate that gold consumption in 2013 doubled over the previous year, to 1,139 tons. Based upon these figures, China has only one source of gold. Arrivals through Shanghai and Shenzhen do not appear, nor does gold acquired from domestic mines. China is the largest producer of gold with an estimated production of 430 tons, but the figures show none of these other sources.

According to Mine Web, the estimated consumption is closer to 2,430 tons with all sources taken under consideration. World production of gold is placed around 2,500 tons. This means that China is acquiring most of world production and that imports are drawing upon reserves elsewhere.

During January, 643,000 ounces of gold was transferred from J. P. Morgan. The gold appears to have been acquired in October 2013 for an unidentified client and delivered in January. As the bars are the type preferred in China, it is believed that China was the buyer.

Jeffrey Nichols, managing director of American Precious Metals Advisors, said in January that he is expecting the PBOC to disclose its gold holding this year. He calculates that gold reserves have more than doubled to 2,720 tons. Compared to the United States’ 8,000 tons, it is a minor amount, but what is interesting is the determination that the PBOC is demonstrating by its secretive. non-stop buying.

China has become such a major player in the gold and other precious metals market that the Shanghai Gold Exchange is now the largest gold market in the world. It, however, is limited to spot contracts.

The Chinese are intending to convert the exchange into an international exchange with a variety of derivatives and yuan-denominated gold contracts as China moves to gain an important position in setting global prices in order to break the dominance of the London daily gold fixing price, which has come under criticism.

A popular view is that all of these activities are steps to make the yuan into a gold-backed reserve currency to replace the U.S. dollar. Keeping in mind that the foremost interest of the Chinese Communist Party is the preservation of its power, the economic reforms needed to create a yuan reserve currency to challenge the U.S. dollar could be, in the end, political suicide.

The yuan would have to be freely convertible, capital flows would have to be uninhibited, and there would have to be a liquid bond market and accessible banking system. Beijing will, in effect, be relinquishing much of its control over a vital sector of the economy. Controlling the financial system is essential to being able to direct which sector of the economy will be favored.

Three decades ago, Deng Xiaoping advised his successors not to be too eager to assume a leading role. A leader has responsibilities and obligations that he warned the following generations to avoid until China has the means to be a leader. An important segment of China’s leadership believes that the time has not arrived yet.

While the debate about why China is accumulating gold is occurring, China is not the only country doing so and not the only government dissatisfied with the domination of international economics by the United States and its currency. Over recent years, Russia has doubled its gold holdings to 1,034.7 tons, which equals 8.3 percent of its reserves. During April, while selling U.S. Treasury bonds, Russia purchased 30 tons of gold. As the fourth largest producer of the yellow metal, the Russian central bank has a ready supply.


Russian President Vladimir Putin has expressed his opposition to the domination of the world economy by the U.S. dollar. Since the conflict with the U.S. and the EU over the seizure of the Crimea, Western sanctions imposed on Russia have started the process of creating a separate financial system. Russia, China, and others complain that Washington has employed the dollar and powerful American financial institutions as weapons to compel friend and foe alike to comply with its demands.

The use of financial institutions as a weapon was demonstrated when Visa and Master Charge stopped processing the accounts of Russia Bank, Sobinbank and SMP Bank – all of which are thought to be owned by close colleagues of Putin. Sobinbank and SMP Bank had service restored, but the message was loud and clear. It was time to replace Visa and Master Charge credit cards that control 90 percent of transactions with the Russian based UEC system and with the Chinese Union Pay system. The conversion is being treated as a matter of national security and will divert the estimated three or four billion dollars earned in fees by Visa and Master Card to Russian businesses.

Another phase in Russia’s move to foster a separate system from the dollar is to accept currencies other than the dollar in payment for crude oil. It is reported that Russia is making even more crude available outside of the dollar system by being the sales agent for 500,000 barrels per day of Iranian crude.

China, which is Russia’s largest market, has an unusual arrangement to conduct trade in their respective currencies. The $400 billion energy agreement signed in May is the largest commercial arrangement in history and binds both China’s and Russia’s economies. Joint naval exercises in the East China Sea and in the Mediterranean are intended to impress the world with their unity, but it is common economic interests that have joined these two for an historical moment. Their common objective is to contain the United States by a means short of a military conflict. The weapon is money.

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The Russian economy is resource-based and only 3 percent of the global economy. There is no way that Russia could displace the U.S. dollar with the ruble.

China is the second largest economy in the world, but the yuan is far short of becoming a reserve currency. There will have to be many essential reforms of the financial system, and the leadership in Beijing has little desire to establish the yuan as a reserve currency.

What the recent Marxist societies are doing is to revert to the basics of the original international economic system, when nations depended upon gold or silver as money. The system that was adopted after Bretton Woods replaced precious metals that cannot be manufactured by human beings with a paper standard that could be increased at will by simply running the printing press. The United States acquired a near instant empire, with the dollar serving as carrot for the compliant and a stick for the defiant.

The new super-currency will be based upon a reserve of precious metals that will include gold, silver, and platinum with possible metals from the platinum group. What value will be placed upon the precious metals can be decided daily by a metal fixing at the Shanghai Gold Exchange that expects to be broadening the range of commodities traded.

Joining the new super-currency does not mean the instant death of the dollar as a reserve currency. There will be no problem for countries to function within the two parallel systems. In fact, it may prove to be a beneficial move for global commerce. As the U.S. sees its current account turn from a long-term deficit to a surplus, due to the development of gas and oil within the U.S., a shortage of dollars to fund international commerce could see the value of the currency strengthen after years of steady depreciation.

If the politicians in Washington decide that the United States will not tolerate a currency rival and move to block the parallel monetary system, the Russians and the Chinese can revert to the days of the Cold War when the philosophy of mutual assured destruction served to impose discipline upon both sides. In this case, the common weapon of mass destruction will be money.

The Federal Reserve Bank carries 8,000 tons of gold on its books as three quarters of reserves. The Fed, however, refuses to allow an audit to confirm that it indeed actually holds the gold. Many believe that the gold has been leased to bullion banks. It has taken the Fed seven years to return five tons of gold to the Germans, who have been holding 300 tons in the New York vaults and have asked to have it returned.

The unwillingness of the Fed to ship the gold on demand causes some to wonder if it has been loaned to the bullion banks that are unable to return it immediately. The suspicion that other central banks have also loaned out their holdings has prompted the Austria’s central bank to send auditors to London to confirm whether or not their bullion is still being stored where it should be.

With gold at a near equilibrium in supply and demand, it would not be difficult for the largest and fourth largest producers to bring down the world economy by making it impossible for the borrowing bullion banks to go into the market to replace the borrowed bullion at double or triple the price at which it was acquired. The next Pearl Harbor could be a press release from the Chinese and Russian central banks to the Wall Street Journal that they are adding large quantities of gold to their reserves. If suspicion that the central banks have mismanaged world affairs under a cloak of secrecy turns out to be true, that would trigger financial chaos.

By Felix Imonti Oilprice.com

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Leave a comment
  • zipsprite on June 04 2014 said:
    What does it mean for a central bank to "lease gold to bullion banks"? How does that work?
  • suzanne scott on June 10 2014 said:
    well done well explained article Felix knows his macro economics and politics wish we here in the US grasped even a little of this and applied it

Leave a comment

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