China, Greece, Gold, and the SDR

Economics, Premium POM

Could This Be the Real Reason for China’s Gold Accumulation

By JC Collins

With both Ukraine and Greece on the verge of defaults, it is time for the world to take collective action on a sustainable solution and path forward. The growing crisis will require the framework of a multilateral approach, as no unipolar, regional authority, or single monetary union can adequately address the depth and severity of the threat. Any real solution cannot be to the benefit of any one country. With that thought in mind, let’s review some of the upcoming milestones over the next few weeks and how they may relate to the sovereign debt restructuring.

The BRICS Development Bank will be officially launched on July 8-9 in Russia.  The importance of this event cannot be overstated, as it is the first major launch of such an institution in decades.  The fact that it is eastern oriented as opposed to western serves to underscore the importance and reality of the emerging multilateral system.

It is being reported by Zero Hedge that an IMF delegation is traveling to China for meetings on June 15 and 16, to discuss the inclusion of the RMB into the SDR composition.  This is expected and late, as it was originally scheduled to happen in May.  I’ve been unable to confirm this meeting but we can assume that the information is accurate.

Russian President Putin and Greek PM Tsipras will be meeting at St. Petersburg International Economic Forum which is being held from June 18 – 20. They will be discussing energy projects which could facilitate the cash-for-reforms segment of any debt restructuring that will take place.  Pipelines will be high on the agenda in this meeting.

Though it may appear to be unrelated, the deadline for the Iranian nuclear deal by the end of June in all probability will play a huge role in how the geopolitical end of this sovereign debt challenge unfolds. Once sanctions are lifted vast amounts of Iranian oil will flood into the market which will drive valuations even lower.  This will be the second shoe to drop for high cost producers, such as shale in the United States.

This week former US Treasury Secretary Larry Summers stated that America was facing the threat of global economic isolation.  The implication is that if the United States continues to drag out reforms to the IMF and prevent multilateral adjustments in the monetary framework, such as the RMB being added to the SDR, the outcomes for their own sovereign debt challenges will become less sure.

It is publically stated that the CIPS, or China International Payments System, will be active by the September/October timeframe.  There is a very real probability that CIPS could be activated much sooner to facilitate a quickening of RMB internationalization.  This will allow for Chinese autonomy from US centered financial market structures, which is what Larry Summers was referencing.

CIPS will begin in Shanghai and will handle deals in Asia, Oceania, and Europe.  The importance of Europe in the start-up phase of CIPS is extremely important.

The western governments and institutions cannot bailout all countries by themselves.  This includes the US, EU, IMF, and World Bank.  As stated above, a multilateral approach is required.  The argument will be made by some why BRICS and China would save the western governments and institutions.  The obvious answer is that they also have their own challenges and will also require the assistance of a multilateral framework to build and ensure confidence in their growing and adapting economies.

The bond crisis which is growing world-wide is really a lack of confidence.  There are many methods available to restructure sovereign debt but until those multilateral tools are agreed upon and made available, there will need to be a method of plugging the dam and preventing a spread of defaults.

Though we could be looking at a process where defaults by some countries, such as Greece, are allowed to happen, but are managed to reduce the level of systemic risk to the broader international economy.

The idea of using gold as collateral for highly distressed bonds is not new.  In the 1970’s Italy and Portugal used their gold reserves as collateral on loans from Bundesbank and the Bank for International Settlements.  In 1991 India used their gold reserves for loans from the Bank of Japan and elsewhere.

The Euro area has over 10,000 tonnes of gold which could be used as collateral on distressed bonds.  But that alone would not be enough.  The gold reserves of Greece, Ireland, Italy, Portugal, and Spain only make up 3% to 4% of outstanding debt.

The accumulation of gold by the BRICS countries over the last few years has been dramatic.  There are no hard numbers on actual accumulation amounts from China, but some assumptions can be made.  The total reserves of the BRICS nations together would be equal to or greater than that held in Europe.  Potentially even Europe and America combined.

In the post A Solution to the European Crisis, we reviewed how each Eurozone member could redenominate their debts in domestic currency and allow for a depreciation of the domestic currency to facilitate a reduction in a portion of the debt.

A similar process could be followed if another portion of the debt was redenominated in a foreign currency, such as the RMB.  Central banks, and the PBoC, could use their balance sheets to lower yields on highly distressed bonds.

If RMB denominated bonds were issued through the SGE with gold as collateral, much of Greece’s debt could be exchanged and a default managed with the help of China, BRICS, and gold reserves as collateral.

The yield reduction on gold backed debt issued through RMB bonds would be further securitized with the expansion of RMB liquidity when the currency is added to the SDR composition.  The internationalization of the RMB will change how the international monetary system functions.

A multilateral approach to sovereign debt defaults and distressed bonds as described here could very well become a reality in the coming months.  The importance of multilateral adjustments, such as adding the RMB to the SDR, will be important in the realization of sustainable solutions to the world’s economic challenges.  – JC