China, Gold and International Money

A major monetary transition is fast approaching...

SOMETHING happened on Friday that is worth noting, writes Dan Denning, editor of the Daily Reckoning Australia.

Wikileaks got tired of waiting for the mainstream media to sift through all those US diplomatic cables. Some 65 gigabytes of uncensored US diplomatic cables were set free on the Internet late Friday afternoon. The data mining has begun.

One interesting item that's been published already is that China views gold as a weapon against the US Dollar. A US diplomatic cable from April 28th, 2009 – gold closed at $906.20 in New York that day – quotes Chinese media on the subject of currency warfare and gold. Under the subject, China increases its gold reserves in order to kill two birds with one stone, the cable reads (emphasis added is ours):

'The China Radio International sponsored newspaper World News Journal (Shijie Xinwenbao)(04/28): "According to China's National Foreign Exchanges Administration China's gold reserves have recently increased. Currently, the majority of its gold reserves have been located in the US and European countries. The US and Europe have always suppressed the rising price of gold. They intend to weaken gold's function as an international reserve currency. They don't want to see other countries turning to gold reserves instead of the US Dollar or Euro. Therefore, suppressing the price of gold is very beneficial for the US in maintaining the US Dollar's role as the international reserve currency. China's increased gold reserves will thus act as a model and lead other countries towards reserving more gold. Large gold reserves are also beneficial in promoting the internationalization of the RMB.'

This cable reveals that one primary method of intelligence gathering for US diplomats is to read the local papers. GK Chesterton defined journalism as, "writing badly on an enormous scale" and the journalist as, "one who is vastly ignorant about many things, but who writes and talks about them all."

Perhaps now we know why American intelligence gathering has been so poor in the last 20 years. It's taking its cue from the media. But it's not surprising that the first step in open-source intelligence gathering is to see what's in the papers. That tells you what the social mood is.

In fact, some traders are even trying to harness "social mood" as a predictor of stock market prices. There are products out there now that promise to track Twitter trends and issue you buy and sell alerts derived from social media trends. Check out Wall Street Birds. Prepare to laugh.

Other products are based on the same idea but sound a lot more complex. They are based on artificial neural networks – computer networks and software designed to mimic the structure of the human brain. The programs claim to be self-learning and adaptive and, of course, predictive. They claim to help you anticipate future stock behavior by analyzing rapidly evolving social trends.

The idea sounds plausible. It appeals to a kind of emotional logic that if you collect enough real-time data about what other people are doing and saying, the right algorithm can tell you what they're about to do. Now that social media like Twitter and Facebook are producing so much output, you just need to aggregate the data, crunch it, trade it, and rake in the dough, baby.

But we're not sure there's any real advantage in knowing what other people are thinking, especially if they're not thinking. The social media aggregator/neural network stock prediction theory promises to operate the same way a price does in a free market. That is, it promises to communicate useful information by reducing millions of different individual sentiments into one.

A price IS useful information, as long as it is not distorted by, say, easy credit. Easy credit causes people to spend more money than they have. Producers of goods and services react to this and overestimate consumer demand. Real resources are misallocated based on bogus price signals.

But a neural network that tells you what people are Tweeting about can't possibly tell you what BHP stock is worth, can it? No. Why? Because what people are thinking about is not the same as what they are actually doing with their money. Prices measure human action. Indicators that measure sentiment are useful. But sentiment fluctuates. It's subject to manipulation. And basing your financial decisions on the quality of other people's aggregate thinking is the same as not thinking at all.

That was a long diversion from China and gold. But really both subjects – gold and neural network/Twitter stock prediction theory – are about absolute vs. relative value. The Chinese know that the consensus belief in the US Dollar as a reserve currency requires the suppression of the Gold Price. The rising Gold Price communicates useful information to investors: fiat money is a fraud.

In the Chinese view, gold has a real value no matter what people think about it. It has absolute value. This is why China is planning for a new world reserve currency in which gold is remonetized. Our guess is that they are aiming for a 2015 launch, in which the Yuan is partially internationalized and included in the IMF's special drawing rights basket of currencies.

The logical end of a monetary crisis is a reissuing of currency and a revaluation of that currency relative to gold and silver. This is what happened in 17th century England.

Back then, English silver was underpriced. That is, the silver content of English coins was worth more as silver on the Continent than it was as a sovereign coin. Arbitrage ensued. Speculators bought silver coins in England at face value, melted them down, and sold them in Continental Europe for a profit.

Newton concluded that in Europe, the natural ratio of gold and silver in circulation was 15:1. He suggested a recoinage of English money and a revaluation of the currency. Both took place. And off England went to a century of Imperial dominance with sound money. 

Our point? We are nearing a major monetary transition in world history. It will inevitably involve the disappearance of some currencies and the emergence of new ones. You don't need Twitter to tell you that. And you don't have to be a neuroscientist to know that the new global reserve currency is going to be at least partially backed by gold.

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