And What This Means for the Price of Gold
By JC Collins
Two interesting things happened over the last few days. The Chinese yuan experienced a single increase over one night which equates to the largest appreciation in a decade. This was paralleled by a 5% decrease in the price of gold. A depreciation which is continuing as I type. The interesting thing about economics is that you can spin data and numbers any which way to support a given theory or sales pitch. So I’m not suggesting that the above two events are directly connected through a process of cause and effect.
With that being said, I have suggested in previous posts over the last few years that reserve currency diversification will put additional downward pressure on the price of gold. As USD denominated securities are exchanged and substituted for euro and yuan denominated reserves, the demand for dollar alternatives becomes a reality, and the amount of gold investment will decrease.
This has been an extremely challenging aspect of the multilateral transition for many precious metals investors to grasp, and one I’ve attempted to promote without ruffling too many feathers. Though I have at times. Confidence in this position does not equate to arrogance on my part, though I understand why some would interpret my matter-of-fact writing in such a manner.
One of the positions which many analysts have adopted over the years is that there are no alternatives to the USD, and as such gold will be the big winner in the event that the dollar experiences a depreciation, or outright collapse into hyper-inflation.
But this position does not consider the multilateral monetary framework which is being developed behind the scenes. This is a framework which will provide alternatives to the USD and allow for a re-balancing of the international monetary system. A re-balancing which will work towards removing the threat of systemic collapse and financial volatility.
The announcement of the inclusion of the Renminbi in the SDR basket composition is imminent and should take place in a matter of days, or a few weeks. Though there has been speculation that the effective date of the new SDR will not take place until next October, which would buy the United States one additional year of deficit budget funding before the crunch of dollar depreciation and interest rate increases. This could change as the announcement of the new basket takes place.
There are multiple paths forward on this SDR transition. The RMB could be added directly into the main SDR composition at full value, or it could be added at a sliding scale type model where the weight of the RMB in the SDR increases over the next 5 years. This weighting increase would correspond with further capital account liberalization of the yuan, which would lead up to full convertibility by the year 2020, at which time the full weighting of the RMB in the SDR would be realized.
The other possibility, though one which is less likely, is that the RMB will be constituted into its own SDR2 composition which will serve the same purpose, but remain isolated from the machinations of the main SDR basket. (This would benefit the US and allow for additional time for the unwinding of USD denominated reserves.) A similar process of sliding scale weighting increases could take place, with the consolidation of both SDR1 and SDR 2 during the IMF review in 2020.
We will know soon enough which path forward the International Monetary Fund and China will take.
Either way, what is clear is that demand for the Renminbi will increase dramatically after it is officially sanctioned by the IMF, whether it’s SDR1 or SDR2.
In fact, there could be $500 billion in RMB reserve demand once the announcement is made. This accumulation of RMB denominated reserves will begin the process of mass diversification away from the USD denominated reserves. It is important to remember that the USD will still remain as a viable reserve asset, and will remain as such amongst the other top reserve assets, the euro and RMB.
The large increase in the yuan the other day corresponds with the anticipation of the SDR announcement, as well as a trial program in the Shanghai Free Trade Zone which will allow for domestic buyers to purchase foreign assets. The PBoC has also stated that it will be looking at additional methods of implementing looser capital controls.
What is slowly emerging throughout the international monetary framework is that a stronger renminbi is becoming a political priority. Even the US understands the importance of diversifying the foreign exchange reserves and allowing the dollar to weaken against the currencies of its trading partners.
This depreciation of the USD will correspond with the beginning of monetary policy normalization. The likelihood of the Fed increasing interest rates in December is improving. As I’ve stated continuously, this is exactly what the US wants. Domestic jobs will increase with the increase of American exports. In turn, the debt-to-GDP ratio comes down and America will be able to look at more sustainable fiscal budgets in the years to come.
Trump and his mantra of making America great again falls exactly in line with the multilateral monetary transition which I have been describing for almost two years now. On top of what I’ve already stated, Trump is now coming out saying that Janet Yellen has not raised interest rates because Obama told her not too. Apparently Obama doesn’t want to see the bubble burst under his watch.
But like the political pressure is building for a stronger renminbi, there is an equal amount of pressure building for an increase in interest rates. Policy normalization is being promoting by everyone from the BIS, IMF, to regional and central banks. Even the emerging markets themselves are starting to get on the rate increase bandwagon and stating that the Fed should just get on with it.
The unwinding of this debt bubble, and USD reserves, will cause some initial volatility and not all corporations and investment vehicles will survive the transition. The availability of a strong dollar alternative will mean that capital flows from the USD to the RMB will take place. The expected rush into gold which many have predicted as the dollar depreciates will not likely materialize as expected.
This does not mean that gold will collapse in value, but it could very well settle around the $800.00/oz range for a few years. There could be some gold appreciation realized on the upward swing towards the year 2020. But it’s hard to predict at this point.
What is clear is that massive reserve diversification is starting to take place, and the rise of an alternative to the USD will mean less opportunity for gold. Renminbi demand is about to explode, and the demand for gold will suffer in the interim. - JC