Precious metals mining: The pros and cons of the gold standard

Bloomberg IntelligencePrecious Metals Mining

Let’s examine the pros and cons of China adopting a gold standard.

China Return To Gold Would Aid Yuan, Bring Other Problems

Were China to set the yuan to a gold standard, it would potentially destabilise the currency and require an exchange rate of $64,000 an ounce, based on Bloomberg Intelligence analysis.

China, the world’s largest gold consumer, is trying to establish the yuan as a globally recognised reserve currency. A gold standard would help China quickly establish the currency’s reserve status. A return to the gold standard would be a complex move, involving complications with reserves, price and monetary stimulus.

China aims to make the yuan a global reserve currency

China’s Currency Supply Is Ample, While Its Global Trading Is Not

China’s long-term goal is to make the yuan a global reserve currency—to do that the Chinese must make the currency freely convertible. The sheer amount of Chinese currency, as measured by M2, is staggering.

At the current pace, China will have more M2, in U.S. dollar terms, than the U.S. and euro combined by late 2015. If not properly managed, making a currency freely convertible could destabilise it. China may opt to back its currency, either implicitly or explicitly, in some form with gold.

Chinese Yuan Is No. 5 Most Traded, Yet A Blip On Global Reserves

The yuan does not even register as a significant global reserve currency, hence China’s motivation to adopt a gold standard. The yuan is relegated to the ‘other’ category by the IMF, barely used by global central banks as a reserve currency. Impediments to the yuan’s free flow have been responsible for this historical lack of use.

This is rapidly changing as the yuan is now the fifth most-traded currency. China aims to open up its currency market to major flows and to have the yuan become an important reserve currency.

The U.S. dollar is seen as safer than gold

Gold Imposes Discipline—That’s Why Central Bankers Hate It

Central bank actions can drive up gold prices, even as bankers often disdain the metal because gold-backed currencies limit their abilities to manipulate money flows and M2 supply. In most cases, central banks are limited in their ability to affect gold.

The U.S. dollar is seen as safer than gold given that, currently, the Federal Reserve’s money supply growth is not enough to increase inflation. This keeps pressure on gold prices. Investors in emerging markets use gold to combat intentional currency devaluation and inflation.

China Gold Standard Would Need $64,000-An-Ounce Exchange Rate

China could put the yuan onto a gold standard, depending upon the setup, what is backed, the ratio, and the exchange methods as well as the transparency. The backing could be implicit or explicit.

If China wanted to back its base currency on a M0 currency basis, with 10,000 metric tonnes of gold, it would need a current exchange ratio of $3,111 an ounce, in dollar terms, based on BI calculations. For M1, the dollar figure rises to $16,918. If all of M2 is backed, the ratio would be more than $60,000 an ounce.

Gold Standard Embrace Could Boost Gold’s Stocks, Ease Bank Runs

If only one major currency is backed by gold, enough of the metal could theoretically be acquired to increase its stocks. In China’s case, the government could always increase the ratio of yuan per ounce of gold to ensure that it does not trigger a run on the bank.

China would still be able to manage its money supply to a great degree, while the global market would know that, unlike any other currency on Earth, the yuan is backed by a precious metal.

100-Year Gold Prices

Why Would China Consider A Gold Standard? To Preserve The Yuan

If China were to switch to a gold standard, one of its motivations would be to assure the world that its currency is tied to something globally recognised as a storer of value.

China is seeking to diversify its economy by encouraging inflows of foreign capital; one way to entice capital in-flows would be to back its currency with something such as gold. The ratio, and mechanism of exchange from the yuan to gold, might have to be altered to account for the amount of gold held by China.

Chinese gold imports from Hong Kong rose to 523.6 metric tonnes a year in 2012

Chinese Stock Market Crash Could Channel Investments To Gold

Chinese investors have been moving away from real estate into the stock market at a record pace. If the Chinese stock market falls back as it did in 2007, it could move the public to another asset class such as gold.

China did see a surge in the buying of gold in the years after the 2007 collapse. Chinese imports of gold from Hong Kong rose to 523.6 metric tonnes a year at the peak in 2012, from 75.5 in 2008. Any swoon in Chinese equity markets makes gold flows worth watching.

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