The Ins and Outs of Chinese Gold Reserves

Here we go again. Markets have caught a chill after signs of inflation fever in China. And that’s not even the half of it. Let’s dive in…

Consumer price inflation in China hit a 16-month high in February – a 2.7% year-over-year increase. China’s National Bureau of Statistics was quick to put out a statement reassuring everyone that “price rises this year will be moderate and controllable,” but that’s not enough to calm traders looking for excuses to feel jittery.

And any news that might, possibly, at some point in the future, signal monetary tightening in China…well, that’s enough to put the fear of God in them. Hence, the major US indexes opened down about 0.2% in the first hour of trading. The news is also an excuse for traders to bail out of gold, which clings to $1,105 as we write.

So much for the short-term noise from China. But the Middle Kingdom is also making real news this week. We’ll get to that in a bit, but first, we bring you this item to help put it in context.

Right in line with analysts’ forecasts, Uncle Sam’s budget deficit for the month of February was $220.9 billion – the largest monthly total in history. For the first five months of fiscal 2010, the total is $651.6 billion, 10% ahead of last year’s blistering $589.9 billion pace.

The details are even fuglier. Total revenues: $107 billion. Total expenditures: $328 billion. Yes, that’s only one dollar of revenue for every three dollars spent.

We have just two words for this: Banana. Republic.

So what does China make of numbers like this? As it happens, the National People’s Congress is holding its annual session this week. During the festivities, Yi Gang, the head of the Chinese State Administration of Foreign Exchange assured the world that US Treasuries would remain a major component of China’s reserves.

We noticed he said little about whether China would actually add to its positions and soak up some of that additional debt racked up last month.

Yi also pooh-poohed any role for gold in China’s wealth management strategy: “It is, in fact, impossible for gold to become a major investment channel for China’s foreign exchange reserves,” he said. “I have 1,000 tonnes now, and even if I doubled that holding, according to current prices, that would be about $30 billion…” barely a drop in the big bucket that contains $2.4 trillion of China’s forex reserves.

Of course, that’s what face the Chinese government puts on for the public.

Yet “the volume of China’s gold reserve in terms of its forex reserves only ranks fifth in the world, and is well below the global average,” says Russell Hsiao of the Jamestown Foundation.

Hsiao rounded up some interesting stories from Chinese media that shed additional light…

  • The Guangzhou Daily reported in 2008 that China’s central bank was considering raising its gold reserve by 4,000 metric tons. (It’s currently 1,054 metric tons.)
  • Ji Xiaonan, the chair of the supervisory board for major state-owned companies under the Chinese State Council’s state assets commission, set an even higher bar last year – 6,000 tons by 2014, and 10,000 tons by 2019
  • According to the English-language website ChinaStakes, a senior official from the People’s Bank of China (PBoC) suggested last year that China should “secretly increase its gold holdings” as part of a long-term plan – with the central bank buying up as much domestic production as possible.

However it turns out, “the long-term implications of Chinese debates to increase its gold reserves,” Hsiao concludes, “will have far-reaching impact on the stability of China’s forex reserves and the yuan’s ability to become the next reserve currency of the world. The question for Chinese leaders now appears no longer if, but how, that will come about.”

Addison Wiggin
for The Daily Reckoning