China’s Preparing for the End Game – Are We Paying Attention?

For three thousand years China has been at the forefront of monetary innovation.  It was the first to legalize gold money in the tenth century BC and two millennia later it issued the world’s first paper currency.  Fast forward to 2012 and China is at it again, eclipsing Australia as the largest producer of gold and increasing its monetary gold reserves at an alarming rate.  Five years ago China surpassed the US in gold production and five years from now it will own more gold than the US Federal government.

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Do not dismiss this as just another example of China’s insatiable appetite for natural resources.  It is not.  China is preparing for a world beyond the inconvertible paper dollar, a world in which the renminbi, buttressed by gold, becomes the dominant reserve currency.

Lest anyone doubt China’s resolve, just consider the following:  The Chinese government has recently removed all restrictions on personal ownership of gold; legalized domestic gold exchange traded funds; is currently purchasing 100% of domestic gold mine production; has imported over 750 tons of gold (27% of global output) in the last 12 months; stated publically its intention to add 1,000 tons per year to its central bank gold reserves; and is buying major stakes in foreign gold mining companies.  The scale of this initiative is extraordinary.

Commenting on the recently announced acquisition of African Barrick Gold Ltd. by state-owned China National, CEO Sun Zhaoxue stated, “As gold is a currency in nature, no matter if it’s for state economic security or for the acceleration of renminbi internationalization, increasing the gold reserve should be one of the key strategies of China.”  This statement regarding the internationalization of the currency through the production and acquisition of gold reserves is in stark contrast to the attitude of Federal Reserve Chairman Ben Bernanke.  He told students at a lecture at George Washington University earlier this year that the problem with the gold standard is that it requires “an awful big waste of resources” to produce the gold.  It seems that what we consider waste, China considers essential for the establishment of a sound currency.

There are two important reasons why any of this matters.  First, the scale of China’s gold initiative is unprecedented in world history.  This alone should make us take notice.  Second, China is signaling that the currency wars of the past decade are changing.  Soon, the battle will be influenced by gold.  Here in the West, we cling to the notion that our experiment with floating exchange rates and unreserved currencies will somehow save the day.  We forget that it was only 41 years ago, when the US suspended dollar-gold convertibility, that our current system was born.  China suffers from no such delusion.  It is voting with its wallet that the experiment has failed.  It is preparing for the demise of the US dollar.

Fortunately, we still have something to say about this.  As long as the US dollar remains the world’s reserve currency, we can act from a position of strength and credibility.  China does not know what the next monetary system will look like – it just knows that when the dust settles, gold will once again be an important monetary asset.  The US can avoid being a victim of this uncertain future by designing and implementing a modernized gold standard.  We have done it before with great success.  In fact, for most of US history, the dollar was defined as a weight unit of gold.  It is no coincidence that we enjoyed our greatest economic growth during those periods.

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