China may crash dollar

10.09.2012 | By Tetyana Pysmenna Komentari:

Mass purchases of gold by Beijing could force up world prices of gold to US $2,000 per ounce and deal a serious blow to the American currency

Leading Chinese economists have recommended the countrys government to increase the volumes of the countrys gold reserves fivefold. The government needs to expand its share of gold in foreign exchange reserves to reduce its vulnerability to the devaluation of the dollar. The reserve should be at least 5,000 tons of gold. It has huge currency reserves and the amount of funds that could be freely mobilized is considerable, wrote the website of the governmental publication Rnmn Rbo

At the moment, Chinas reserves are low (around 1,000 t). Gold reserves account for only 1.6% of the US $3.2 trillion in foreign exchange reserves, while in other countries this indicator averages 10%. In the U.S., the country with the largest reserves, this figure is around 70%.

The fears concerning a possible global economic recession call forth the distrust of Chinese officials to all currencies. In addition to that, an increase in the gold reserves should support Chinas campaign on promoting the yuan as a reserve currency. Increasing gold reserves should be the core of our country´s gold strategy for the purpose of ensuring economic security and speeding up the process of yuan internationalization, said President of the China National Gold Group Sun Zhaoxue in an article. As an argument he said that U.S. gold reserves have helped support the dollars position as a global currency despite the international financial crisis. U.S gold reserves that amount currently to 8.133 t have played a very important role in this.

The intention of China to purchase practically 4,000 t of gold caused a panic among investors. Particularly impressive is the fact that a large share of Chinas reserves that currently exceed US $3 trillion could be dumped onto the market. Experts are already predicting a new surge in prices of the yellow metal that have of late been steadily in decline. If the Chinese government implements its announced program, the price of gold will rise. The question is only how fast. If the volume of gold in the reserves will be gradually increasing, the price of gold could grow to US $1,750-1,800 per troy ounce as early as the fall of next year (in recent months the price of gold hovered around US $1,600 per troy ounce). More aggressive actions on the part of China could lead to an increase in the price of gold to US $1,900 or even US $2,000 per ounce, believes Olena Dudnyk, chief trader of the First International Financial Agency. Also, the increased interest in gold by other worldwide central banks could spark a growth in prices of the precious metal. In April-June central banks were purchasing gold at record high rates. Over this period they increased their reserves by 157.5 t, which is twice higher than the indicator over the same period last year.

The increase in Chinas gold appetites will negatively affect the dollar. The mass exchange of the U.S. currency for gold will certainly look like Beijings disappointment in the dollar. This could stir a panic on the market and provoke new searches for alternatives to the dollar as a foreign exchange currency, particularly if China gradually, year after year, will continue to replenish its gold reserves. Realization that China is becoming the worlds second holder of gold and expansion of the list of countries that exchanged swaps with China will reduce interest in the dollar as a reserve currency in the long-term. This will yield support to all currencies quoted against the U.S. dollar. Also, the gradual alteration of the reserves baskets of countries can be expected. The accents will be shifted towards diversification, particularly in favor of assets of BRIC countries Brazil, Russia, India and China, predicts Serhiy Boriychuk, an expert at the analytical department of Weltrade.

Be that as it may, China, which is the second (after the U.S. Treasury) largest holder of the U.S. national debt to the tune of US $1.132 trillion will not allow a sharp devaluation of the dollar. Injection into the global financial system of an amount equivalent to the cost of 4,000 t of gold will devalue the dollar and therefore the cost of the debt. In addition, one should not forget that China and U.S. are opponents in fighting for geopolitical influence in the world. Since the U.S. is interested in dollar devaluation as it will be easier to repay the debt, China will try to prevent this from happening, noted Boriychuk.

Such a trivial reason as the limited volume of gold output could be an obstacle on the path of Chinas ambitious gold plans. Its annual output is around 2,350 t per year with the demand exceeding 4,000 t. That is why Beijing will be able to sharply increase volumes of gold purchases only in case its regular buyers partially or completely refuse to buy it, which is highly unlikely. At the moment, no new gold deposits are expected, which means that even over 5 years China will not be able to realize its plan for a major increase in gold reserves. The way out is the active purchase of gold on world markets and an increase in Chinas share in foreign gold producing companies. This will allow Beijing to purchase gold for its own purposes dirt cheap. Already now, China is a partial owner of key international gold producing companies, such as Norton Gold Fields, A1 Minerals, Gold One International, Zara, YTC Resources, Sovereign Gold.

World on the verge of currency wars

Financiers predict a new round of currency wars. The cooling down of economies and a slowdown in the dynamics of global trade growth forces exporting countries to take extreme measures. The most evident of them is the planned devaluation of currencies through interventions on currency exchanges. Using this method they will be able to support their companies and increase export volumes. Developing countries dont want a strong currency, losing export momentum and losing domestic momentum, said Phillip Blackwood, a managing partner at EM Quest Capital LLP in London. They want to boost GDP as much as possible. A weaker currency is another measure they can use.

Manipulations of governments with rates of national currencies has become commonplace in the period of the first wave of the crisis. In order to save the countrys economy the Swiss Central Bank decided to take a risk and suspended the growth of the national currency by pegging the Swiss franc to the euro. Also, in an attempt to fight for a weak yen the Japanese government sharply increased the supply of its currency on the market.

The slowdown in consumer demand in Europe stiffens competition among those countries for which Europe has been a traditional market. Moreover, the pressure on the currency exchange rates remains significant. Losing faith in the stability of the U.S. dollar investors are seeking a new safe haven for their money. Indeed, they are increasing volumes of investments into government bonds of developing countries.

On the backdrop of Germany, Denmark or Switzerland, whose profitability has become negative and high-risk bonds in the European periphery, the bonds of developing countries look very attractive. It is highly possible that quite soon developing markets will start building a defense wall to prevent the influx of hot capital, including through the introduction of taxes on profits from investments into government bonds and limitation of currency derivatives trading.

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