The People's Bank of China already has more gold than the US Treasury

Our world is experiencing radical and disruptive changes at an accelerating speed. Many of those changes go totally unnoticed. In this article I want to call your attention to one of such changes, which won't have immediate implications because it will remain unnoticed for some time yet, but will definitely have a profound impact in the coming ten years.

China's economic revival has given the country the willingness to exert more influence and power in the world. It has global ambitions of its own, and to achieve them it needs to blunt the existing American-made order and dethrone the US dollar. President Xi Jinping and his administration advocate a more assertive foreign policy and are determined to transform the power balance and the rules which underpin the global political, monetary and financial system.?China has already been taking a number of steps to weaken the financial advantages that underwrite US hegemony, and gold is likely to play a role to achieve it.

Thousands of years of history have taught us the value of precious metals. No amount of crypto tokens, much less meta worlds of NFTs, are going to change that, as fun as they might be. Gold keeps its value while fiat money is doomed to suffer from inflation. In spite of closing an unremarkable year, gold has definitely been among the top places in 2022 in terms of asset class returns.

Here are several introductory and relevant facts about the gold market that we have to bear in mind and most people are unaware of:

• According to Metals Focus’ Gold Focus report, China was the largest gold producer in the world in 2021, followed by Russia and Australia. These countries hold more than 30% of the known reserves worlwide. Chinese production has increased from 320 Tn in 2009 to 332 Tn in 2021 (around 9% of the world production). It is important to stress that gold mining does not respond quickly to prices. The project development timelines are long and can take more than a decade to move from discovery to production.
• Switzerland, India, United Kingdom, China, and Hong Kong were the largest gold importers in 2021. Collectively, this cohort of major gold buyers bought well over two-thirds (69.5%) of the world total. Switzerland's case is a special one because it is the biggest refining and transit hub for gold, housing four of the world’s five largest gold refineries. Therefore, it ends up exporting most of the gold it imports. Likewise, the UK is one of the top exporters too. This is not the case with China: in addition to being the largest producer, China as well as Hong Kong are among the top gold importers. China usually imports most of its bullion from Australia, South Africa, and Switzerland.
• In fact, China has traditionally had strict controls on exporting gold and in the past it was barely allowed. Nevertheless, what really counts is net balance between exports and imports. In the following table you can see that India and China were the top net importers of gold in 2021.

• Finally, China has a much more pro-gold mentality than the West. Today's China rose from poverty in just one generation. Deng Xiaoping said "To get rich is glorious". China's GDP skyrocketed in a few decades and the country became home to the second-highest millionaire population. In Chinese culture, gold is associated with power, wealth, longevity, and happiness. Chinese people consider the accumulation of wealth and financial stability their first priority, and China has a long history of trade and business.

The official gold reserves of the People’s Republic of China are held by the People’s Bank of China (PBoC), China's central bank. According to the Chinese State Administration of Foreign Exchange (SAFE), official gold reserves are currently in excess of 1,948 Tn. However, Chinese gold reserves are believed to be far larger than reported by the PBoC / SAFE. Due to official Chinese secrecy in this area, it is difficult to quantify the potential size of gold reserves in excess of reported levels. Despite this, evidence exists that the PBoC has purchased a very large amount of additional tonnes of gold since 2009.

The following table shows the countries with the largest foreign exchange reserves as of the 3rd Q 2022, their gold holdings (i.e. central banks have traditionally held reserves of gold to safeguard their financial systems), and their percentage allocation to gold.

Therefore, according to official data China holds the world’s sixth largest gold reserves behind the United States, Germany, Italy, France, and Russia. During 2022 the suspicion that China was loading up on gold spread again and in early December, China’s central bank confirmed it had bought 32 Tn a month earlier, the first increase since 2019. However, there are legitimate suspicions that?China is not reporting the real number.

The official data raise several questions:

1. How can China, the country with the largest reserves in the world and with a clear pro-gold mentality, allocate such a low percentage to gold?
2. Why does China, the second largest economy in nominal terms and the first one in terms of PPP (purchasing power parity), own less gold than Russia, a much smaller economy?
3. Does China really own less gold than Italy (2,452 Tn), a country with a GDP one eighth the size of China's, which is even smaller than China's external reserves?
4. Does anyone believe that China owns less gold than the sum of Taiwan, Kazakhstan, Turkey, Uzbekistan, and Portugal?
5. Does that make any sense in a country aspiring to recover world leadership after three centuries (back in 1820, China was by far the world’s largest economy)?

The Chinese regime has never been exemplary in terms of transparency, and everything points to the fact that China's gold holdings are much larger than this country acknowledges. China has experienced more than 20 years of relentless gold accumulation.?Domestic production, imports, and gold withdrawals at the Shanghai Gold Exchange, established in October 2002 by the PBoC to become the central hub of the Chinese gold market,?all have skyrocketed over the last decades. In fact, during 2022 Swiss gold exports to China surged to a 6 year high.

Back in 2015 several observers wondered what was going on and Bloomberg Intelligence already estimated that the gold holdings held by the PBoC were larger than the official figures. On which basis can we state that China's gold reserves are larger than what the country recognizes?

• China’s 1,980 Tn (69.84 M ounces) of gold reserves are fairly low compared to most other countries. This is particularly striking if we take into account that China has by far the largest foreign reserves in the world after several decades of huge trade surpluses.
• In 2007 China overtook South Africa as the world’s largest gold producer. It has remained so ever since. During the 2010s it produced about 15% of all the gold mined in the world.?Since 2000, China has mined roughly 6,830 Tn of gold. Over half of Chinese gold production is state-owned and China keeps the gold it mines – the export of domestic mine production is not allowed.
• China is not only the largest gold producer in the world. Chinese mining companies have been very active buying gold mines abroad, across Africa, South America and Asia. Please check out several of the latest examples: one, two, three, four, and five.
• Whether imported, mined or recycled, most of the gold that enters China goes through the Shanghai Gold Exchange (SGE), including the gold imported from Hong Kong. So SGE withdrawals can act as something of an approximation for demand: since 2008, almost 22,000 Tn have been withdrawn from the SGE. However, not all gold entering China is accounted for by SGE withdrawals. The PBoC has a particular interest in buying 12.5 kg bars, which do not trade on the SGE. The PBOC often uses dollars on exchanges in London, Dubai and Switzerland, while the SGE sells its gold in yuan.?
• Additionally, the People's Liberation Army?of China is the only army in the world with a Gold Mining Unit, which is responsible for establishing and protecting gold mines. This unit owns gold too, and does not have to declare its purchases. As in Russia, other government agencies besides the central bank can buy and hold gold without reporting them as reserves to the IMF. For example, the State Administration of Foreign Exchange or the China Investment Corporation (China's sovereign wealth fund).?

If we combine the different sources (cumulative domestic production, imports, and existing stock) we arrive at a figure well above 30,000 Tn of gold. It turns out that the world’s top gold analysts – Ross Norman, Bron Suchecki, Alasdair McLeod, and Koos Jansen – arrive at similar or even higher estimates.?Please note that even if only half of that gold is state owned, the implication is that China owns close to twice as much gold as the US.

The accumulation of gold by China has certainly accelerated over the last years. Why is that happening?

1. During?inflationary periods gold creates a fine balance in central banks’ overall reserves as rising global inflation means decline in the value of all major currencies including US dollars against real assets like gold.
2. Deglobalization and geopolitical tensions increase the willingness of central banks outside of the West to diversify away from the US dollar. Financial markets remain blind to this trend, but the widespread flight of central banks to gold suggests that the geopolitical backdrop is one of mistrust, doubt and uncertainty. As deglobalization accelerates, the non-G10 nations are likely to ‘re-commoditize’ and ramp up gold holdings.
3. Additionally, 'rogue states' now have another good reason to not rely on the US dollar as their main reserve asset. Since Ukraine invasion, western governments have frozen 300 B USD of Russia’s foreign currency reserves through sanctions, leading non-western nations to wonder if it makes any sense to be exposed to so many dollars when the US and western governments can confiscate that at any time.

It has been two years since gold hit new all-time highs and 2022 has definitely been a rather difficult year for the shiny metal. In an environment characterized by soaring interest rates and a very strong US dollar, everything was in place for gold price to collapse, but it didn't. Why? Despite the correction experienced during most of 2022, we have seen significant support. Without such support, the jump in interest rates and the strong US dollar could have easily sent gold below $1,500.

As the chart above shows, the gold price broke in late November the downward trend it had held since March 2022 and its simple 20 day MA (moving average) jumped above the 50 day MA first, and in December above the 200 day MA, providing a key bullish signal. Now that?US inflation seems to be moderating after reaching the peak of the current wave in June 2022, investors are starting to anticipate a less aggressive Fed in 2023, thus causing the US dollar to come under pressure and helping gold price.?

In his outlook for 2023, Saxo Bank's respected commodities strategist Ole Hansen said he believes gold could hit $3,000 an ounce once the market realizes that inflation will remain high despite historically aggressive monetary tightening.

But China is not alone in this process. A recent article by Financial Times shows that central banks are buying gold at the fastest pace since 1967. Other relevant investors, such as Russia's sovereign wealth fund, Australia's sovereign wealth fund, and a growing number of institutional investors are increasing their gold holdings as well. Observers and central banks know that inflation is not going away anytime soon, thus jeopardizing the value of fiat currencies held as foreign reserves. Additionally, they also recognize that there are ever more signs that the heyday of the US dollar’s reign may be coming to an end.?As a result, they prefer to increase their exposure to gold.

The most surprising part is that the current system has played a key role in helping China accumulate gold at a low cost. Since the collapse of the Bretton Woods system, when President Richard Nixon announced the "temporary" suspension of the US dollar's convertibility into gold, IMF members have been free to choose any form of currency exchange arrangement except for pegging it to gold. Indeed, article 4, Section 2b of the IMF's Articles of Agreement specifically prohibits member states from fixing currencies against gold. As a result, with the goal of stabilizing its currency, starting with the Asian Financial Crisis of 1998-1999 China fixed the yuan against the US dollar.?Such a fix and/or managed "float" insure a weak currency, causing Chinese goods to be cheaper than similar goods sold by western counterparts. This system entails a huge competitive advantage and helps China support employment and, therefore, political stability.?

Ever since the gold standard was discontinued, banks have been managing their 'paper gold books' with one assumption, which is that leading countries would ensure gold will not come back as a settlement medium. In other words, since gold no longer supports fiat money, it would not be used as a medium of exchange, leaving it as a collectible, a pet rock, and nothing else. As a result, banks can profitably short gold as much as they wish and use unlimited rehypothecation fearlessly. Substituting gold for US dollars as a settlement medium makes its price cheap in dollar terms.?Thus, it is not surprising that gold price has been under pressure by bullion banks, which are the ones who participate in the London Bullion Market Association and act as market makers for precious metals markets. Most of these banks have paid multi-billion dollar fines to various regulators after being proven guilty of spoofing (placing bids to buy or offers to sell futures contracts and canceling them prior to the deal's execution so as to create a false picture of demand or false pessimism in the market), market-rigging, price manipulation, and other unscrupulous practices.

In 1912, American financier and investment banker J.P. Morgan famously remarked "Gold is money. Everything else is credit." Gold has been used as money for thousands of years, and in times of social, economic, and political chaos, it continues to play its role. However, during the 1960's increasing US monetary growth led to rising inflation, which spread to the rest of the world through growing US balance of payments deficits. As official dollar liabilities held abroad mounted with successive deficits, the likelihood increased that these dollars would be converted into gold and that the US monetary gold stock would eventually reach a point low enough to trigger a run. By 1964, official dollar liabilities held by foreign monetary authorities exceeded that of the US monetary gold stock. The US put considerable pressure on other monetary authorities to refrain from converting their dollars into gold, until Nixon had to suspend gold convertibility on 15 August 1971, due to French and British intentions to convert dollars into gold.?

So now, through de-dollarization and by provisioning an alternative oil payment system (e.g. disrupting the petrodollar system), China is laying the foundation of a more levelled playground, weakening the global demand for the US dollar, lessening the capacity of the US to issue global credit, and hence, lessening its imperial rents.?It could also unleash an economic revolution if in a joint move with Russia and other emerging countries they found a way for gold to play a role in trade settlements.

Along these lines, Credit Suisse strategist?Zoltan Pozsar has been arguing in several notes that we are witnessing the birth of Bretton Woods III – a new world (monetary) order centered around commodity-based currencies in the East that will likely weaken the Eurodollar system and also contribute to inflationary forces in the West. He underlines that this process will take several years to develop and under no circumstances should it be ignored or belittled. While there are a few flaws in Pozsar's reasoning, I couldn't agree more with the underlying trend?he draws our attention to.

Why does China not recognize its current gold reserves? There are important reasons not to declare (yet) such large holdings:

1. The recognition of the largest gold holding in the world would cause an unwanted surge in China's currency (i.e.: the renminbi (RMB) or Chinese yuan (CNY), both often used interchangeably).?This would hurt China's export competitiveness and trade account. Bear in mind that China is the world's largest exporter and it also has the largest trade surplus, which acts as a driver of economic growth. Consequently, for the time being China has no need to brag about its gold holdings and doing so would actually be counter-productive because it would create competitive disadvantage.
2. Even though there are good grounds for concluding that China's gold holdings are above what the PBoC recognizes, the level of reserves remains to be confirmed, To the extent that China is still in the process of reaching the desired goal (remember that China revealed gold buying in December), there is no need to overheat the market by announcing future acquisitions.
3. A stronger currency would also imply that China's humongous foreign exchange reserves would experience a sudden devaluation (foreign currencies would become weaker against China's currency). This is relevant because China is currently the country with the largest foreign exchange reserves in the world. As of November 2022, China had $3.12 trillion in foreign exchange reserves and it is silently diversifying them to reduce its dependence on the US dollar. Since 2019, Japan has substituted China as the largest foreign holder of US Treasuries. In that respect, the recent alleged "pivot" by the Bank of Japan is likely to add more pressure to US rates as well as to the US dollar.

On a side note, regardless of the hesitation that the headline of this article may generate, it should also be underlined that the official gold reserves of the US Treasury should be questioned because they haven't undergone a serious audit for quite a long time. To make matters worse, decades ago audits were executed with an inadequate degree of integrity and many serious questions arise from reviewing the available information.

As Zoltan Pozsar summarizes, "since the conclusion of the Cold War, the world enjoyed a unipolar “moment” – the US was the undisputed hegemon, globalization was the economic order, and the US dollar was the currency of choice. But today, (...) for the first time since World War II, there is a formidable challenger to the existing world order, and for the first time in its young history, the US is facing off against an economically equal or, by some measures, superior adversary". If we are transitioning from globalization to a multipolar world (G7 + Australia, BRICS+, and the non-aligned), it is impossible that this split will not affect the international monetary system. It is difficult to forecast when China will launch its final effort to strip America of its power and authority in the world, but the alleged massive gold accumulation over the last decade is a clear step required to do so. After all, as the old saying goes, "in times of crisis he who owns the gold, makes the rules".

__________________________________________

If you liked this article, please recommend it or share it.

Carles Iborra?has worked more than 15 years in the wealth management business and is the founder and CEO of IIR, an investment research firm. He is also a Partner at Dextra International, a leading advisor in the crop protection business, and worked previously as the Managing Director of a foreign Family Office and as a Project Leader at The Boston Consulting Group, helping large corporations to boost growth and improve profitability. He has broad experience in wealth management, financial markets, and strategic management.