Global investment firm Pimco believes China is unique. They claim the Chinese won’t be pursuing a strategy of currency devaluation. I find that hard to believe.
We live in a world where currency debasement is widespread. Central banks across the globe use it to boost struggling economies.
They do this to weaken their currency. A weaker currency makes exports more competitive. That in turn helps economies grow.
Lowering interest rates and stimulus spending are both forms of currency devaluations. Anything that infuses the economy with more money debases the strength of a currency.
Pimco doesn’t believe China will resort to this. Instead, China will be too busy preparing the Renminbi (RMB) for reserve currency status.
A reserve currency status is desirable for China for one major reason. Countries would need to hold more RMB reserves than they do today. That’s because the RMB would have a greater role in world trade.
The more RMB reserves other nations held, the lower the exchange rate risk for China. And managing the exchange rate is important for China. It would remove some of the elements associated with currency volatility.
Pimco isn’t wrong in saying that China aspires for reserve currency status. But China must continue to debase its currency to prevent its economy from declining further.
The PBoC have cut rates by 60 basis points in the last five months alone. GDP growth is slowing, and economists expect China to miss its 7% target this year. Manufacturing and trade both fell year on year, as demand for housing declines.
The Chinese can lower interest rates much further. That’s because interest rates are still at a relatively high 5.1%. It’ll depend on how urgent the needs of the economy are.
But currency debasement doesn’t imply that reserve currency status is unattainable for the RMB. That’s because gold is far more important in this equation.
Let me explain…
Why China has been stocking up on gold
The Chinese have ramped up imports of gold in recent years. The PBoC has been purchasing gold in huge quantities.
In 2013 China imported 1524 tonnes of gold. With domestic production the total intake for the year was at 1952 tonnes. In 2014 China added 1702 tonnes of new gold reserves. And this year imports were at 410 tonnes in the first two months alone.
Gold is important for China’s future reserve currency ambitions for one significant reason.
Imagine if nations lost trust in the US dollar’s status as the reserve currency? An alternative would need to be put in place. This isn’t just a possibility — it’s already happening. The $400 billion bilateral gas deal between China and Russia is one such example.
In fact there are already calls for the IMF to move towards a new basket of currencies. This would serve as a new reserve currency using several influential currencies.
The stature of each currency may be influenced by the amount of gold backing it. And that’s what makes China’s existing gold holdings so important. Far more significant than what Pimco attributes to the devaluation of the RMB.
While this all still speculation, it helps explain China’s insatiable gold purchases. If the RMB is to assume a greater role in global finance then gold will play a big part.
Contributor, The Daily Reckoning
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