Gold & the Yuan Standard

China needs to internationalize the Yuan. Commodity and gold pricing is a good start...

CHINA seems likely to encourage moving pricing of some internationally-traded energy products and commodities into the Yuan, writes Julian Phillips at GoldForecaster.com.

This would promote use of a "Yuan Standard" for both hedging and borrowing transactions and, over time, would lead to both exporting and importing countries using Yuan in their foreign currency reserves. 

Already China will trade oil with Russia for roubles and Yuan. We see this form of trading spreading to the nations that value China as a trading partner wherever they may be in the world. This will ensure that a growing percentage of Yuan will find their way into global reserves, in place of the Dollar. In turn, the US will attempt to tighten its grip on nations that value it as a trading partner. The implication, over time, is that the oil market will feed the western-oriented world taking Dollars for oil and Asian markets, taking the Yuan for oil.

It is the impact of such changes that will create tensions, instability and uncertainty regarding the value of currencies. As it is, the US relies on the Dollar's value through its hegemony in the global economy. The breaking of that grip will damage the current monetary system, just as a crystal glass is very different when cracked.

The lessening of the Dollar's presence in the monetary system will add considerably to its weakening on foreign exchanges as well as influence on the global economy over time. We may even see the day when the US foreign exchanges are made to diversify into other foreign currencies (including the Yuan?). It may be that the US actually has to accept the loss of a good portion of foreign capital from its Balance of Payments and bring its Trade Balance close to a balance.

It's these future strains that will lead to political tensions as well as currency uncertainty as never before. And we believe this is one of the fundamental reasons why the Chinese are very keen on gold as a big part of their reserves as well as part of the future monetary system. It's not an academic position, but one of pragmatic necessity. Again this is why the Chinese authorities have shown evident interest in promoting Yuan pricing for gold in Hong Kong and on international markets.

This is of such importance that, over time, we will see two more Daily Gold Fixings to be set in either Honk Kong or Shanghai, reflecting the growing Chinese demand and supply of gold there. China alongside London, if not ahead of it, will be the global hub of gold markets. So we will see a 24-hour gold market with the Chinese markets working closely with the London bullion banks setting the daily Fixings and being the home of the physical gold markets.

An important role will be played by the Chinese authorities' overriding policy of announcements regarding gold. So far an agency of the People's Bank of China buys gold for them, handing the gold over every five years. The date of the next handover is 2014. With both the government and private citizens, and together with the widespread perception that the Chinese authorities are covertly building up gold reserves, Beijing will act in a manner consistent with ensuring it remains a good investment. 

To us this means issuing sufficient Yuan internationally that the currency does not appreciate to the detriment of the Yuan gold price internally, and to its and its citizen's holdings of gold. This also implies an ongoing interest in acquiring gold for its reserves and not to reach a specific percentage of its reserves.

Needless to say, it would prefer to 'manage' the value of the Yuan against gold ensuring that price volatility were contained and the value of gold trend higher against the Yuan over time. Again this gives scope for the control of both government and private gold holdings.

We have painted the way forward for gold in broad sweeps in this article, with much of the detail subject to the future changes, but the broad direction of a global monetary system removing the overriding influence of the US and making room for an independent self-interested China (leading Asia). 

Asia, in time, will become the dominant economic bloc with more than half the world's population. The huge changes this implies cannot be made without tremendous pressures affecting currency values the world over. 

With the Yuan not present in the table of global reserve currencies, it can only rise at the expense of the US Dollar and the Euro. The desire to diversify will weaken the two main currencies. The currency crises may follow the pattern set by the Pound Sterling in the early 1970s for these demanding Capital Controls until the adjustments have been made.

In such an environment gold will become not simply an important reserve asset but also a strategic monetary metal in each nation's hands. Not only does this imply much higher prices, but a need to control gold markets to ensure its stable performance and that it is not subject to huge swings at the hands of speculators – such as we have seen in the last two months.

Certainly if China decides that it is to its advantage to build a substantial store of gold, then it will ensure it can be used to lessen liquidity constraints, internationally and mollify currency crises that emanate from them.

We believe that it may well insist that other nations use their gold in the same way.

The only way this can be done effectively – as OMFIF mentioned in its recent report for the World Gold Council, and as we have also said before – is to use gold as a form of 'value anchor' indexing currencies to gold. We see this as being somewhat brutal on some nations making them look at the realities of their currency's value, but also reinforcing the monetary system as a whole.