China's splurge on gold adds intriguing twist to trade war
There are some interesting aspects to the surge in the gold price to its highest level in nearly six years, not the least of which is that China has been buying gold while selling US Treasury bonds.
In fact it's not just China. Central banks generally have been diversifying their reserves away from US Treasuries. According to the World Gold Council they bought 145.5 tonnes of gold in the first quarter of this year, the most since 2013.
The gold price has soared as trade tensions rise and global growth falters.
Photo: BloombergIn the past week alone the price shot up almost 10 per cent, to $US1408.80 an ounce, with the depreciation of the Australian dollar pushing the price in local currency terms to record levels above $2000 an ounce.
The movement in the past week points to one of the factors driving the price. The 9.8 per cent spike appears to have been a direct response to last week's US Federal Reserve Board's meeting, which signalled likely cuts to US official interest rates later this year.
With the European Central Bank also talking about resorting to more stimulus to try to reflate a spluttering eurozone economy, and China's economy slowing as the Trump administration's trade war bites, the prospect of lower growth and even lower rates in an already low-rate global environment are encouraging risk-averse investors towards the safe haven of gold.
Gold is sensitive to interest rates, to the value of the US dollar and to heightened concerns about economic growth and geopolitical instability. All those are present today in the global economy.
The emergence of China as a significant buyer adds another dimension to the resurgence of gold.
The People's Bank of China has bought more than 70 tonnes of gold since December after having being virtually out of the market for the previous two years. Russia has also been a massive buyer, adding about 274 tonnes to its reserves last year.
Even as it was splurging on gold, China has been selling US Treasuries. Its holdings of Treasury bonds peaked at $US1.32 trillion in late 2013. Today they are about $US1.1 trillion ($1.6 trillion). China's ownership of US public debt peaked at about 14 per cent of the debt on issue in 2011; today it is about half that level.
China's banks could effectively be shut out of the US-dominated global financial system if the administration decided to deploy its nuclear option in the trade war.
The gradual lowering of its buying of Treasuries has sparked concern that China could retaliate against the US imposition of tariffs on $US250 billion of its exports to the US, and the threat of tariffs on the remaining $US300 billion or so, by dumping its bond holdings.
With the issuance of Treasuries at record levels of around $US1 trillion a year thanks to Trump's $1.9 trillion of tax cuts, that would force US government borrowing costs up sharply, spilling over into the cost of all debt in the US and choking US growth rates.
It isn't likely that China would do that. Apart from the losses it would incur if it simply dumped a large proportion of its US bond holdings, really large-scale selling would cause the US dollar to depreciate heavily against the renminbi, undermining China's competitiveness and creating the potential for a destabilising flight of capital.
There's also the small matter of finding somewhere else for it to park the funds it would release – the US Treasury bond market is the deepest and most liquid of markets and, unlike the other major sovereign bonds markets in Europe and Japan, offers still solidly-positive yields.
Nevertheless, China and Russia's gold-buying points to a desire to diminish their exposure to the US market and a direct exposure to the US dollar.
One potential concern would be the way in which the Trump administration has weaponised the US dollar, using its status as the world's reserve currency and the dominant currency for world trade to enforce its sanctions against Russia and Iran.
With the administration only recently (but perhaps predictably) announcing new rules that would enable it to arbitrarily impose "countervailing duties" – tariffs – on countries that "artificially'' lower the value of their currencies, China might be concerned that Trump will seek to use the threat of other forms of sanction as leverage in its trade conflicts.
China's banks and other organisations could effectively be shut out of the US-dominated global financial system if the administration decided to deploy its nuclear option in the trade war.
That possibility, while perhaps faint, also explains why both China and Russia have been trying to encourage the use of the renminbi and rouble in global trading and while the Europeans, also targeted by Trump, have been trying to devise mechanisms at arms' length to their traditional banking channels for circumventing the chilling effect of the renewed US sanctions on Iran.
Insurance against the aggression of the US may be one aspect of gold's appeal to other central banks. But that deterioration in the relationships between the US and its major trading partners, and the increasing impact it is having on global growth, would by itself promote a diversification of foreign exchange reserves and exposures away from the US and, in the process, an increase in the gold price.
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