Follow the Gold

Longitude n. 81 - 2018

By Danilo Broggi, author of the book Diario di Bordo - Tra innovazione e cambiamento.

America built its superpower status on the strength of the greenback, which since 1944 has ridden off the value of gold. Now China and Russia are scrambling to nab as much of it as they can, to offset protectionist tariffs and hedge for a new cold war. Only problem is, gold production has reached its peak.

Last November, Sergey Shvetsov, First Deputy Chairman of Russia's Central Bank, clarified Russia's position on a new gold trade system: “The traditional (trade) system based in London and partially in Swiss cities is becoming less relevant as new trade hubs are emerging, first of all in India, China, and South Africa,”he said, adding “we are discussing the possibility of establishing a single system of bilateral contacts.” According to the World Gold Council, Russia is the main official gold buyer and the third major gold producer in the world. Over the past ten years, it has more than doubled the rate of gold purchases, adding more than 1,250 tons to its gold reserves. In the second quarter of 2017 it accounted for 38% of all gold bought by Central Banks. China, who last year announced the discovery of the world’s largest gold mine is concurrently the major producer and importer of gold. It owns the fifth largest gold reserve in the world after the United States, Germany, Italy and France (leaving out the IMF International Fund). But there are rumors among operators that China has yet more sizeable gold reserves. But what is the reason driving Russia and China in particular into focusing on the rarest and most sought-after metal in the world? 

Apparently there is a war going on, both in terms of currency and business protection (that is economic) where the US, China and Russia are the main contenders. This war aims to curb the power of the “green bill” on the economies of the eurozone countries. Let’s try to understand this a little better. The Bretton Woods agreements in 1944 established the dollar to gold standard at $ 35 per ounce. It worked successfully for 30 years until the amount of dollars in the financial market exceeded the gold reserves. In 1971 Nixon breaks the agreements and establishes the free fluctuation of the dollar which thereby becomes (and still is) the leading currency. Dollars constitute 63.5% of the total amount of currency reserves (IMF source - III Quarter 2017), but this is an indicatively lower rate when compared to the 64.6% in the third quarter of 2014. Euro’s amount to 20%, also now lower when compared to 22.6 % in the third quarter of 2014. The Yen and British Pound follow at around 4.5% as regards both currencies. The Chinese Yuan is at 1.1% worth, increasing from 1.08% over the previous three quarters and from the initial zero (it is noteworthy that traditionalist Bundesbank has planned to include the yuan in its currency reserves). So the dollar, although firmly in command in currency terms, has weakened and has to face an ever changing global political and economic-financial situation. China keeps growing and Xi Jimping’s second unlimited mandate consolidates the country’s political stability as well as long-term economic and financial planning capability. The same applies to Russia with the confermation of Putin’s fourth term. While Trump’s “American First” is forcing the consolidation of trade and strategic agreements between China and Russia (One Belt One Road). The BRICS member countries (Brazil, Russia, India, China and South Africa) encouraged by China and in agreement with Russia (after the eighth summit in India in 2016) have begun to design a new financial architecture by establishing the New Development Bank (NDB), the BRICS contingency reserve fund (CRF) and the Asian Infrastructure Investment Bank (AIIB). Moreover, the American political situation shows elements of poor cohesion: at the recent World Economic Forum in Davos Steven Mnuchin, the US Treasure Secretary, maintained: “Obviously a weaker dollar is good for us in terms of trade and opportunities.” The next day Trump declared he preferred a “strong dollar”. Omer Eisner, chief market analyst at the Commonwealth Foreign Exchange in Washington, then commented: “I have the feeling that the dollar is increasingly suffering from the unpredictability of this administration’s decision-making”. And China seems intent on not letting this opportunity slip by. The institution of the CIPS (international payment system) in accordance with SWIFT - the international banking clearing system - ensured the inclusion of the yuan in the currency basket on which the special drawing rights are based (IMF means of payment) and on March 26, China listed local-currency crude futures in Shanghai, according to the nation's securities regulator. 

For the first time since 1971, there is an important petrodollar competitor in the shape of a yuan alternative that will be partially convertible into gold at the corresponding futures value. A triple-win mechanism (oil/ yuan/ gold) will completely bypass the US dollar. The era of the “petro-yuan” seems to have started. It is not by chance that Xi Jinping has recently replaced the “legendary” Governor of the People’s Bank with Yi Gang, who among other key objectives, has set himself the task of achieving the full effectiveness of the yuan, in China’s ultimate move to establish itself as an economic and financial power. 

Yet gold production seems to have reached its peak. In a press conference held in September of last year Randall Oliphant, in his capacity of President of the World Gold Council, warned about the possibility that global gold production has reached its peak. In other words, supply will not be able to meet demand. For some time now China has been offering the chance to trade the yuan with real gold at the Shanghai market through the Shanghai Futures Exchange. Over time, the cash flow in yuan futures should improve and Shanghai is already the major market of real gold. Due to the link with Moscow the importance of the Shanghai Gold Exchange will increase. 

“Buy king dollar and sell gold”. This was one of the first declarations that Larry Kudlow released to the press as the new number one of the National Economic Council following on from Gary Cohn. Yet dollars can be printed (in theory as many as you like) while gold must be extracted. 

In order to better understand what is going on at a global political and economic level, perhaps we ought to go from “follow the money” to “follow the gold”, to quote the title of Karl Marx’s well known book.