China Proves it is Desperate

China Proves it is Desperate

In early August, the Chinese government insisted it wouldn’t devalue the yuan against the US dollar.[1]

Then, on 5 August, the government flipped, ‘allowing’ the yuan to trade below seven yuan for every US dollar for the first time ever.[2]

This move was widely viewed as retaliation to the US-led trade war.

As the Nikkei Asian Review noted last week, with the yuan trading at 11-year lows against the US dollar, more people are looking for ways to move their money out of China. [3]

The Middle Kingdom is looking for new ways to prevent real estate developers from buying foreign currency bonds.

Plus, there’s additional scrutiny being applied to local Chinese banks and their foreign currency reserve trades.

As Jim notes below, China isn’t doing well in the trade war.

And its flip flopping on policy decisions demonstrates how desperate it has become.

Read on for more.

Until next time,

Shae Russell Signature

Shae Russell,
Editor, The Daily Reckoning Australia

China Proves it is Desperate

Jim Rickards, Strategist

Jim Rickards

Last week, I wrote that China was banning imports on gold.

Shortly after, I was flooded with inquiries concerning the announcement.

This came as a shock to many.

China has systematically more than tripled its gold reserves in the last 10 years.

The official figures show that China increased its gold reserves from about 600 tonnes to about 2,000 tonnes.

However, there is good reason to believe these figures are understated and that China’s actual gold reserves are significantly higher…

Preventing capital flight

The 2,000 tonne figure only represents official reserves.

Chinese citizens hold much more privately. Chinese mines produce about 500 tonnes of gold per year, but China needs much more than that to satisfy government and private demand.

This is where gold imports fill the void.

In recent years, China has been importing over 1,500 tonnes of gold each year to meet demand.

At the current price of about US$1,500 per ounce, these gold imports would use up about US$80 billion per year of hard currency reserves.

What readers wanted to know was whether the gold import ban represented a sudden halt in China’s interest in gold.

If true, that could have negative implications for the world gold price.

My analysis was that the announcement had nothing to do with gold, and everything to do with capital controls and trying to preserve China’s depleting reserves of hard currency.

China’s reserves dropped by over US$1 trillion in 2016 due to capital flight.

Excluding precautionary reserves to bail out its banks and certain illiquid assets, China has only about US$1 trillion left to defend its currency and pay for imports.

China went too far

China is suffering a dollar shortage today because of capital flight, and because its trade surplus is drying up due to Trump’s tariffs and the trade war.

Banning gold imports was a way to hang on to US dollars.

A recent article from Reuters confirms my analysis. The news site reveals the demand for gold in China was too strong to cut off completely, saying:

China’s central bank had for several months curtailed or not granted import quotas to commercial banks responsible for most of the gold that enters the country, Reuters reported last week.

Sources said those measures had possibly been designed to reduce capital outflows and bolster the yuan, which has slumped to 11-year lows against the dollar as a trade dispute with the United States batters China’s economy

The central bank began to issue quotas again last week, but for lower amounts of gold than considered normal, three people with direct knowledge of the matter in London and Asia said – without specifying exact amounts.

Beijing has previously taken steps to curb capital outflows when its currency weakened. These steps included some restrictions on gold imports in 2016, sources have said.

No clear data for capital outflows exist but a measure from China’s balance of payments called errors and omissions points to US$88 billion leaving in the first three months of this year, the most on record.[1]

Limited permits have now been granted to begin importing some gold, but in smaller quantities than in the past.

China is between a rock and a hard place.

On the one hand, it wants to preserve its US dollar reserves.

On the other hand, the demand for physical gold in China is too strong to cut off completely.

The irony is that a lot of the gold that comes into China via the front door soon leaves through the back door via illegal smuggling and other forms of capital flight.

In the end, China loses the US dollars and the gold.

All the best,

Jim Rickards Signature

Jim Rickards,
Strategist, The Daily Reckoning Australia