China, the yuan, the dollar and gold. Where is it all heading?

Lawrie Williams
I have just published an article on Mineweb which looks a little more deeply at the possible impacts of the Chinese yuan becoming part of the IMF’s Special Drawing Right basket en route to it being acceptable as a global reserve currency. This seems to be China’s aim, but we don’t see how it can happen without some major currency structural changes, and these could have a very significant impact on the future of global trade and on gold and it could force China to announce the long awaited uprating of its gold reserve this year – as many have speculated it will.

We see any move to bring the yuan into the SDR basket as necessitating China decoupling the yuan from the US Dollar. The SDR basket is made up of a mix of currencies – the dollar, euro, pound sterling and yen, the idea being that between them this provides broad stability in the SDR’s value over time and that bringing in a currency which is tied to one of the others already in the basket would defeat the overall objective! Thus to participate in the SDR we suggest that China will have to drop the currency peg to the dollar and allow it to float freely.

See: What happens to gold when the yuan floats free of the dollar?

The ramifications of this are potentially far greater than the financial markets have probably been anticipating. They have been assuming that in order to add credibility to the Chinese currency’s entitlement for inclusion in the SDR that China will at long last announce a big increase in its gold reserve – some reckon this will be upped to at least second place among globally held gold reserves – there is even a suggestion that it could usurp the U.S.’s position as the world’s No. 1 gold holder, although most discount this. For it to have any effect on the IMFs deliberations, due to be entered into next month with the decision to be made by October, such an announcement would have to come within the next few months – perhaps as early as in the next few weeks.

But be this as it may it is the ramifications of a freely floating yuan that is perhaps most concerning to the current U.S. dominance in world trade. The yuan is seen as undervalued and if allowed to float could rise sharply against the dollar – or rather the dollar might be seen to fall sharply against the yuan. There has even been the suggestion that the recent strength in the dollar has actually been strength in the yuan, to which as noted the dollar is tied, in anticipation of the unpegging of the two currencies and subsequent revaluation of the latter.

This could all be seen as a prerequisite for the yuan to take its place as a – not the – global reserve currency. But another point we made in the Mineweb article is that once China has achieved the level of gold reserve it is comfortable with and is deemed necessary to cement the yuan’s place on the world stage, it has every incentive to intervene and allow gold to rise at a steady pace, given its past policy of persuading its citizens to buy precious metals. An increasingly wealthy middle class, given this sector of the population is growing so fast, would be both a way of ensuring its continuing popularity as well as a way of boosting the overall economy.

Whether any, or all, of this comes about we will have to wait and see – but we may not have to wait long.

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