Is the Gold Price Dependent on China?

China now buys more gold than the Western world:

Gold_Demand_China_WGC

Does that mean, as some commentators are suggesting, that future price growth for the gold price depends on China? That if the Chinese economy weakens and has a hard landing or a recession that gold will fall steeply?

There’s no doubt that the run-up that gold has experienced in recent years is associated with the rise in demand for gold from emerging markets and their central banks. And indeed, the BRIC central banks have been quite transparent about their gold acquisition and the reasons for it.

Zhang Jianhua of the People’s Bank of China said:

No asset is safe now. The only choice to hedge risks is to hold hard currency — gold.

Indeed, this trend recently led the Telegraph’s Ambrose Evans-Pritchard to declare that the world was on the road to “a new gold standard” — a tripartite reserve currency system of gold, dollars and euros:

The world is moving step by step towards a de facto Gold Standard, without any meetings of G20 leaders to announce the idea or bless the project.

Some readers will already have seen the GFMS Gold Survey for 2012 which reported that central banks around the world bought more bullion last year in terms of tonnage than at any time in almost half a century.

They added a net 536 tonnes in 2012 as they diversified fresh reserves away from the four fiat suspects: dollar, euro, sterling, and yen.

The countries driving the movement toward gold as a reserve currency by building their gold reserves is that they are broadly creditor nations whose dollar-denominated assets have been relatively hurt by over a decade of low and negative real interest rates. The idea that gold does well during periods of  falling or negative real rates held even before the globalisation of U.S. Treasury debt.

The blue line is real interest rates on the 10-year Treasury, the red line change in the gold price from a year ago:

fredgraph (15)

The historical relationship between real interest rates and the gold price shows that it is likely not “China” per se that has been driving the gold price so much as creditors and creditor states in general who are disappointed or frustrated with the negative real interest rate environment in dollar-denominated assets. What a slowdown in the Chinese economy (or indeed the BRICs in general) would mean for the gold price remains to be seen. While it is widely assumed that a Chinese slowdown might reduce demand for gold, it is quite plausible that the opposite could be true. For instance, an inflationary crisis in China could drive the Chinese public and financial sector into buying more gold to insulate themselves against falling or negative real rates.

Of course, this is only one factor. That are no hard and fast rules about what drives markets, especially markets like the gold market where many different market participants have many different motivations for participating — some see gold as an inflation hedge, some (like the PBOC) as a hedge against counterparty risk and global contagion, some as a buffer against negative real interest rates, some as a tangible form of wealth, etc.

And with the global monetary system in a state of flux — with many nations creating bilateral and multilateral trade agreements to trade in non-dollar currencies, including gold — emerging market central banks see gold — the oldest existing form of money — as an insurance policy against unpredictable changes, and as a way to win global monetary influence.

So while emerging markets and particularly China have certainly been driving gold, while U.S. real interest rates remain negative or very low, and while the global monetary system remains in a state of flux, these nations will likely continue to gradually drive the gold price upward.

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51 thoughts on “Is the Gold Price Dependent on China?

    • Deflation will spark the printing of money that does not exist yet, to honor the CDS (Credit Default Swaps) when the worlds financial institutions balance sheets turn to insovency because of any deflation of assets. Do you understand what leverage is ?

  1. Gold is the GRAND ILLUSION [distraction]; yet only a trivial commodity, used sparingly in electronics and as a supplement to those feeling as if they are not quite, “worth enough,” in and of themselves.

    If people/institutions are buying gold, then it should be for the same reason that they might diversify their portfolio into real estate, hog bellies, or orange juice futures.

    Gold can no longer be used for money because there is not enough of it. It can not be used to back money because, again, there is not enough of it. The value of global GDP increases at a rate that the supply of gold could never keep up with, which would lead to an infinite fluctuation in the value of money, acceptable only if societal productivity increases/decreases.

    If you buy into the concept of money [the abstraction of labor-value], then you have to buy into a system where people are going to have to trust other people to play it straight. Can this be done?, YES, it can be done. It can be done with a system that is as transparent as is possible, with one that nearly everybody understands. Just like driving, if somebody chooses to do their own thing and start running red lights, the rest have immediate awareness.

    This is how money could work, but it would involve allowing the majority of the people in on the deal, and THIS is the ultimate no-no, not only for the ruling elite, but particularly for their toadies in the professional class who will do back-flips and present at their masters’ feet with the morning paper [with a broad smile on their faces] hoping for a scrap or two [redeemable at their local Mercedes of BMW dealership].

    Yes, all these things can work, but the people at the top must want this to work, and unfortunately, the people at the top are there rarely for any other reason other then to line their own pockets. Occasionally, this is not the case, and a Gandhi may appear on the human stage, but, don’t go long on this occurring.

    In the meantime, understand that although money serves multiple purposes [some useful], its greatest value is to the people who use it to steal from the vast majority, either through inflating/deflating its value, abject counterfeiting, or the numerous scams and shell games played by all the various shysters who reside in the back-allies of global commerce.

    • Gold can no longer be used for money because there is not enough of it. It can not be used to back money because, again, there is not enough of it.

      This has always struck me as a kind of absurd argument.

      Money is just anything that people use as a store of value, or a medium of exchange, or a unit of account. Gold is still used quite widely for the latter two things. There are lots of other monies, but gold is still one.

      The value of global GDP increases at a rate that the supply of gold could never keep up with, which would lead to an infinite fluctuation in the value of money, acceptable only if societal productivity increases/decreases.

      The value and purchasing power isn’t fixed.

      • “There are lots of other monies, but gold is still one.”

        Well, that’s the theory, but go to a Burger King drive-up window and hand them some gold. See what happens. Money is generally thought of as universal “legal tender.” What percentage of business establishments are going to deal with your gold?

        “The value and purchasing power [of money] isn’t fixed.”

        The whole point of “sound” money is so the value of the money is kept proportional the amount of good and services produced in the economy. As you know, in a healthy economy, the value of money increases because of increasing productivity [only], not because of over-/under- production of money relative to G&S produced.

        Again, and please forgive my continued ignorance, John, but how do you do the quote boxes?

        • You know, Burger King here in the UK won’t take Japanese Yen, or gold, or dollars. Only British pounds sterling. That doesn’t make those other currencies any less like money.Gold is being used today as a medium of exchange in global oil markets, by for example Iran and India.

          As for blockquotes, I can’t type the html code into this box, because the site will think I am trying to use it, so here’s a site on how to do blockquotes — http://www.w3schools.com/tags/tag_blockquote.asp

        • John, thank you for your kindness :).

          In GB, only the PS is legal tender so all business MUST take it. So, for 99.9% of the population, only the PS is money. No?

        • You’re welcome!

          A lot of the general public have dollar-denominated and Euro-denominated assets, in addition to the few who hold precious metals as a store of value. The medium of exchange is generally pounds sterling (although more often than not the newer electronic form) but let’s not forget barter which is more frequent than many of us like to admit.

          “Money” is really three things, and a medium of exchange is only one of those.

        • Not to beat a dead horse, but money can be “used” as three things. Money, in and of itself, is [again] an abstraction of labor-value, simply a symbol [and a poor one at that].

          Bartering, otoh, is labor-valued traded in kind, the only economics individuals should engage in. Leave it to the groups to rip-off each other with their money-forms, be they paper, electronic, or other magical incantation.

        • I agree with your arguments about fixed supply of gold, versus production of goods and services.

          You say: “The whole point of “sound” money is so the value of the money is kept proportional the amount of good and services produced in the economy. As you know, in a healthy economy, the value of money increases because of increasing productivity [only], not because of over-/under- production of money relative to G&S produced.”

          My main issue is the Banks lending to wealthy connected and collateralised people, who can at times of opportunity (Recession, Depression) pick up real goods at bargain prices, at the detriment of people who have to sell.

          This is how Warren Buffet makes obscene money. He can get finance if necessary to take advantage of asset corrections.

          If I store my labour value in a currency, I don’t want that currency undermined because of a printing press.

          BTW I purchased a 1922 Weimar 50,000 mark certificate to remind me of the history lesson. It will be framed and hanging in my study.

          Gold can not be printed. That is the beauty of it. The most gold is found 100 km from my home, perhaps it was an asteroid, i.e. a one off from the heavens. Google “Golden Triangle”

          See this beauty unearthed this week,

          http://edition.cnn.com/2013/01/18/business/australia-gold-nugget-discovery/index.html

        • BR, the things that work the best [for the majority] are things that are as simple as is possible [absolute Simplicity = absolute Truth]. Nearly complete transparency is what is needed [always], but this rarely [if ever] takes place because vested interests want anything, but.

          If it was actually desired to have a system of money that was sound and worked for all who used it, this would be an easy task to accomplish, but this is not what those who we refer to as, the elite, desire.

          Instead they wish to manipulate all variables to their own advantage, feeling as if they are superior to the common folk because they are able to rationalize their treachery between rounds of brandy, lines of cocaine, or liaisons with women of questionable repute.

          Money, like all things human, can and do represent the extent of human morality, from the sublime [true compassion] to the abhorrent [avarice].

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  3. Impermanence,

    Your assertion that “Gold can no longer be used for money because there is not enough of it” is only true if you assume that every dollar must be backed 100% by gold. This is not a necessary (or even realistic) assumption. (Btw, the total value of the world’s stock of gold is about $8.5 trillion, so it’s hardly a “trivial commodity”).

    Free Banking economist Larry White:

    “Does the US Treasury own enough gold to return to a gold-redeemable dollar at the current price of gold? Yes. At a market price of $1600 per fine Troy oz, the US government’s 261.5m ounces of gold are worth $418.4b. Current required bank reserves are only $83b.

    Looked at another way, $418.4b is 19.9 percent of current M1 (the sum of currency and checking account balances), a more than healthy reserve ratio by historical standards.”

    http://www.freebanking.org/2011/12/22/making-the-transition-to-a-new-gold-standard/

    Under a Free Banking system, banks would be free to choose whatever outside money (base money) that they wanted to use for interbank clearing and settlement. Since gold worked so well for the Scottish and Canadian Free Banking periods (1716 to 1845 & 1817-1935), there’s a strong likelihood that the market would choose gold again for this period (though other proposals have been made).

    What is Free Banking? A good intro by George Selgin: http://www.richmondfed.org/publications/research/region_focus/2009/winter/full_interview.cfm

    • “(Btw, the total value of the world’s stock of gold is about $8.5 trillion, so it’s hardly a “trivial commodity”).”

      Global GDP is about USD50T. So, what do you do, keep adjusting the gold-backing % per unit currency? Thank you very much, but no thank you.

      What you need is something so transparent that any funny business will be seen IMMEDIATELY!!

      “At a market price of $1600 per fine Troy oz, the US government’s 261.5m ounces of gold are worth $418.4b. Current required bank reserves are only $83b.”

      Since the GDP of the US is about USD16T and there is USD418.4B, how is that supposed to work? If you go to a gold-backed system, are you telling me that you want to keep a frl system? What backs all of this pretend money?

      And “free banking” is like free sex, no such animal. [Gas, grass, or ass, everybody pays to play :]. How about, NO BANKING, instead.

      • First, “Free Banking” is not “free” in the sense that there are no profits. “Free” means free from special govt controls or regulations, such as freedom to issue private banknotes and to invest in all kinds of securities. Also, there wouldn’t be things like “too big to fail,” govt bailouts, deposit insurance, or a central bank. In short, it would be laissez-faire banking, which worked very successfully in Canada (1817-1935) and Scotland (1716-1845). Not a single Canadian bank failed during the Great Depression (while of course some 9,000 failed in the US under the Fed’s watch).

        Second: Yes, US GDP is $16 trillion. But M1 (physical money and demand deposits) is only just above $2 trillion. http://www.data360.org/dsg.aspx?Data_Set_Group_Id=2052

        The $418 billion (about 20% of the $2 trillion of M1) in gold would be available to satisfy redemption requests for people who want to redeem paper money and demand deposits for physical gold coins or bullion. What are the chances that everyone would want to redeem their cash or checking accounts for physical gold at the exact same time? Very low–most people would almost never exercise the option of redemption, ever (physical gold is awkward to carry and a hassle to store).

        M2 (M1 + time deposits, savings accounts, & money market funds) is a bit over $10 trillion. But again, people wanting to “cash out” their accounts will almost certainly do so in privately issued banknotes (assuming a Free Banking system), not physical gold.

        For more info, I encourage you to read the interview linked above or to watch this great interview with George Selgin: http://www.youtube.com/watch?v=U_0CNwgL8Rw

        • Some nice articles about the relationship between gold reserves and money supply under a gold standard:

          David Glasner (a titan on money & banking): http://uneasymoney.com/2012/03/23/bernanke-has-trouble-explaining-whats-wrong-with-the-gold-standard/

          Glasner: “under a gold standard, if people want to hold more dollars, more dollars can be created. Yes more dollars can be created out of thin air under a gold standard! The whole point is that any dollars created have to be convertible on demand into gold. Well if people want to hold more dollars, they can be created, and held, just as desired.”

          Nathan Lewis at Forbes:

          http://www.forbes.com/sites/nathanlewis/2012/02/16/the-gold-standard-and-the-myth-about-money-growth/

          Good graphs on banknotes in circulation vs. gold bullion reserves: http://www.newworldeconomics.com/archives/2011/010211.html

          Finally, I want to stress that I do not support a centrally managed gold standard. I want to see a Free Banking system, with gold (or some other commodity, basket, or index) used as the means and/or unit of account of interbank clearance and settlement.

        • The $418 billion (about 20% of the $2 trillion of M1) in gold would be available to satisfy redemption requests for people who want to redeem paper money and demand deposits for physical gold coins or bullion. What are the chances that everyone would want to redeem their cash or checking accounts for physical gold at the exact same time? Very low–most people would almost never exercise the option of redemption, ever (physical gold is awkward to carry and a hassle to store).

          John S, have you not learned the lessons of the the past five hundred years of banking?

          Other than the 106,245 obvious moral reasons that this should not be allowed, allowing a class of people to accumulate this kind of wealth [based upon the above ruse] allows massive distortions to take place in the political system creating massive social instability.

          When the famous English banking case [to determine whether reserve banking was a scam or not] was decided in favor of the banks, this unleashed a pox upon mankind that has destroyed the hard work of nearly every man and woman who has toiled upon this earth.

          Loaning money at interest is a bad idea [bad, bad, bad], one that has resulted in tragedy over and over and over. Just as allowing your gorgeous [and willing] sixteen year old daughter [who just happens to have a massive crush on the stud quarterback] to join the football team for their annual ‘kegger’ is not such a great idea, allowing the least moral examples of our species to loan out money at interests portends even greater peril.

        • Obviously, I have not mastered the block quote thing as of yet, but this will not prevent me from making future attempts. :)

        • “Loaning money at interest is a bad idea [bad, bad, bad], one that has resulted in tragedy over and over and over.”

          You’re opposed to all forms of lending, period, and support a reinstatement of medieval usury laws?

          Sorry, you and I are on completely different wavelengths. Not even the hardest-core of hardcore Austrians would insist on a complete end to loaning at interest.

        • Not even the Austrians? Well, in that case, I better change my entire philosophy of economic thought! :)

          John S, I understand that you are attempting to rationalize this system the best you can, but putting a Band Aid on a gaping wound isn’t going to do so much good.

          The problem is easy to identify, the solution, otoh, is not so easy to see in that so many that have made a living off of their various something for nothing scams.

        • No, not even Austrians. Even Rothbard says loaning at interest is no problem (his beef is with fractional reserve banking, not banking itself):

          “To the extent that banks lend their own savings, or mobilize the savings of others, their activities are productive and unexceptionable. Even in our current commercial banking system, if I buy a $10,000 CD (“certificate of deposit”) redeemable in six months, earning a certain fixed interest return, I am taking my savings and lending it to a bank, which in turn lends it out at a higher interest rate, the differential being the bank’s earnings for the function of channeling savings into the hands of credit-worthy or productive borrowers. There is no problem with this process.”

          http://www.lewrockwell.com/rothbard/frb.html

          I don’t agree with Rothbard’s opposition to fractional reserve banking. But I don’t see how Rothbard can be seen as being opposed to lending money at interest, in light of this quote.

  4. With Nat Gas being the future global energy source, people will need to invest in US Dollars. The US no longer needs Saudi oil, so the Mid East will be left to its own Theocracy. Starved of money they will enter the stone age again.

    China had a chance to issue a Gold backed currency, but now the US will invigorate efforts to gear up production and export of Nat Gas.

    A strategic mistake on behalf of China. Oh well at least the politically powerful and rich can migrate to a refreshed USA.

    There really is an Emperor Peasant syndrome in Chinese culture.

    • Oil is a lot more than energy, e.g., plastics, tons of chemicals, etc.

      But, I agree with you, BR, that when the shit hits the fan, it is the U.S. that will be left standing.

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  6. Nowhere is the misallocation of global capital so easily focused onto one point when compared to the colossal waste of money that is the Large Hadron Collider – deployed in the mysticism mission to find the all allusive “God Particle” – with obviously it not occurring to the relevant authorities that if said particle was found, it would simply suggest to us the question – what created, caused, inspired, and enabled said “God Particle” to exist in the first place? Meanwhile, people starve because they cannot access energy for food production, and we are left with people like Rolf-Dieter Heuer and Peter Higgs who have a truly shocking sense of entitlement.

    Tax the subjects for our research, they scream! They are, in other words, the Welfare Queens of the scientific community.

    http://www.ft.com/intl/cms/s/0/089ccd76-618b-11e2-82cd-00144feab49a.html#axzz2ITqid13S

    • I agree that there is colossal mis-allocation of capital toward scientific projects. Science advances man, yet benevolence takes a back seat.

      Would cheap food in sub-sahara Africa be a good thing? Until there is a social security system that prevents the poor from having multiple people for social security and status reasons, we’ll see a massive growth in the human population.

      An example that relates to this post: How much money is wasted digging up the ground to find gold?

      Australia has plenty of arable land, and sea cost. Food should be ultra cheap, but we export it, so that a lucky few can make obscene wealth while people struggle to buy good wholesome fresh food. Housing should be cheap, but design rules and planning restrictions make housing some of the most expensive in the world.

      Africa which has the ability to feed itself and the world is the new frontier of wealth. That is why China is racing to develop it. Land is more valuable than gold, because at the end of the day land grows food. If you don’t eat you die.

      • “How much money is wasted digging up the ground to find gold?”

        I don’t think it’s fair to call the business costs of gold mining firms “wasted” money. It’s a necessary part of being in the mining industry and making a profit selling gold. As long as it’s profitable, then the market is telling us that value is being added.

        “Land is more valuable than gold, because at the end of the day land grows food. If you don’t eat you die.”

        This seems like a restatement of the diamond-water paradox. It isn’t necessary to choose between the entire category of food with the entire category of gold. Once the need for food is sated, consumers would much prefer to have one more ounce of gold instead of one more ounce of food, thus they are willing to pay far more for gold.

        “Australia has plenty of arable land, and sea cost. Food should be ultra cheap, but we export it, so that a lucky few can make obscene wealth

        If agricultural subsidies are prevalent in Australia, I think they should be stopped (likewise for the US). But aside from that, I don’t think the govt should be involved in price controls for food. If it is profitable for growers in Oz to export food to other countries, I don’t think anyone has the right to stop them.

        • “How much money is wasted digging up the ground to find gold?”

          A funny quirk: in some ways a monetary system based on gold is more Keynesian than the status quo. Under a gold standard, to permanently expand the money supply, CBs have to spend a lot digging up gold. This means jobs and employment for the masses in the gold mines. Hehehe.

        • Perhaps–but gold mining goes on with or w/o a gold standard.

          Meanwhile, the Fed isn’t a slouch at job creation, either :)

          “The Federal Reserve’s Board of Governors employs 220 PhD economists and a host of researchers and support staff… The 12 regional banks employ scores more…

          The Fed also doles out millions of dollars in contracts to economists for consulting assignments, papers, presentations, workshops, and that plum gig known as a “visiting scholarship”… the Federal Reserve spent $389.2 million in 2008 on “monetary and economic policy,” money spent on analysis, research, data gathering, and studies on market structure; $433 million is budgeted for 2009.

          http://www.huffingtonpost.com/2009/09/07/priceless-how-the-federal_n_278805.html

        • There are very very little agricultural subsidies in Australia, that is why small farmers are selling up to big international conglomerates (China) who are consolidating farms and exporting the food. It is tough farming. For example all winter we had cold and rain, sheep struggled, now no rain fro months, and feed running out. If you don’t have a capital buffer (Parent company sends a cheque) you have to offload your stock at a loss. It is tough.

          You said “As long as it’s profitable, then the market is telling us that value is being added.”

          When the desire for gold is based on cultural and other historical reasons then this makes it irrational in a modern world. Holy water is desired. It does not make it rational.

  7. We are now of the opinion that US real interest rates are low in relation to the current gold price and are heading lower, therefore we see the gold price going still higher to $1800 within the next six months. Of course this works both ways, so if US real rates begin rising there could be a serious correction/further consolidation in gold. We are monitoring this situation closely and adjusting our position (and that recommended to our subscribers) accordingly. However we are struggling to see what could either seriously dampen inflation expectations or cause a substantial rise in US interest rates, hence why we are very bullish on gold at present.

    • Remember they rose rates prior to the housing crash. The Fed was more worried about inflation. They have no clue.

      They will raise rates and say inflation is an issue. I am convinced they will do this just to create another buyig opportunity. Panicked 401K investors will switch out of Equities and into safe investments (Gold??) right at the bottom.

    • Central banks unloaded Gold in the late 90s and the private sphere absorbed the demand, the same would happen again, only much quicker this time, I think.

    • Buddy,
      Do you know what the BIS is ? Take a look at Basel 3 and what they are requiring the banks to do with the Gold classification. Tier 3 to a Tier1 asset. Do you want to redo your post after you educate yourself a little ?

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  9. Why did they preserve the “industrial exterior” but transform the interior into some unworkable monument to contemporary minimalism for a Vogue magazine? Privatize all public property!

    • I appreciate the Spam filter (It was distracting , even if I found interesting articles), but do you think all those keywords would put your blog in the top page of Google searches, when people do key word searches?

  10. The bit I struggle to reconcile is that only the oil states are really free to swap to gold.
    Chinas dollar purchases were never about “investment” but currency manipulation.

    It can hoard gold, or it it can hold down the yuan, (or hold up the dollar) it cant really do both.

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  13. It would be intriguing to see what impact a ‘China recession’ would have on the global price of gold. After all, China is officially the largest holder of physical gold bullion. So this is interesting food for thought.

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