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In a move that provides a
glimpse of the future of US dollar and gold, China has allowed its currency
to be traded for the first time in the United States. This is a bullish sign
for gold investors. It is an important step in the country's plan to make the
renminbi an international currency. The explicit move is an endorsement by Beijing
since the state-controlled Bank of China Ltd is at the forefront of this
development.
Although a floating currency allows price moves in both
directions, it is general consensus that the renminbi will strengthen against
the US dollar due to trade imbalances between the two countries. The impact
on commodity markets, including gold, will depend on the extent and speed to
which China allows its currency to rise.
The impact of a free floating yuan will affect commodities
in three angles: economic strength and prospects of global recovery, direct
impact on trade of commodities to and fro China, and the broader knock-on
effect on commodity demand.
Bank of China Expectations
According to Li Xiaoping, the general manager of Bank of
China's New York brand, "we're preparing for the day when renminbi
becomes fully convertible." He added that the bank's goal is to become
the "renminbi clearing center" in the United States. Right now, the
yuan is still tightly controlled by the government. Until the middle part of
last year, the buying and selling was confined to China and was under tight
capital controls. It was in July last year that the government allowed the
currency to be traded in Hong Kong. Its volume has since ballooned to $400
million from a base of zero.
The move by Bank of China comes at a time when the United
States is pressuring to country to let its currency appreciate, blaming it
for making US trade deficit worse. It should be noted, however, that
Beijing's preparation for convertibility also hints at the strength of
China's economy. It is the second-largest national economy in the world. To
be recognized as a global power, it should also have a global currency.
Although individuals and businesses in the United States
can trade yuan in Western banks like HSBC Holdings, this is the first time
that China has allowed a Chinese-controlled bank to engage in similar
activities. This is a stamp of approval on renminbi trading. However, the
Bank of China puts a limit of $4,000 per day (and $20,000 per year) on the
amount that a US-based person can convert. This restriction is basically in
place to minimize currency speculation. There is no limit on the amount that
businesses can convert as long as they are engaged in international trading.
In addition, the Bank of China places no restriction on the amount of yuan
that can be converted back to dollars.
Growing Openness in Beijing
The decision of allow open trading of the yuan can be
traced back to Beijing's growing openness to currency liberalization. In a previous article, we talked about China's (together
with Russia, France, and other countries) intension to create a basket of
currencies to replace the dollar. But "China has a long way to go before
it has a fully convertible currency, and this is an inching step
forward," according to Robert Sinche of RBS Securities in Stamford,
Conn.
Some analysts expect that in a few years, 20-30% of the
country's transaction will be conducted in yuan instead of dollars (the
figure is less than 1% today). Take note that as China becomes more proactive
in pushing its currency, every one US dollar worth of contracts may be
replaced by yuan. In addition, for every seven yuan that is purchased on the
international foreign exchange, it is replacement one US dollar. There is
also a perception that the renminbi is stronger than the dollar is growing.
If you look further down, the impact of using the yuan as
an international currency won't be positive for the US dollar since it will
no longer be used as widely for international trade. The money will add to
the home money supply. This will have a lot of ramifications in the global
economy.
There are skeptics who doubt its growth potential,
however. For example, some say that growth will be checked due to new
regulations. Last month, the Hong Kong Monetary Authority placed restrictions
on banks' ability to provide yuan-related products in the territory. Analysts
believe the regulations are designed to keep speculators from betting on the
currency's movement, which can potentially cause massive disruptions to the
economy. A more immediate obstacle to growth is lack of demand among American
businesses, majority of which still use the dollar for cross-border
transactions. Some people also believe that China may back track if this
proves to be the wrong move. What Beijing is interested in, at this point, is
measured growth in yuan trading.
A lot of investors are looking into buying yuan as a form
of investment, seeing it as a sure bet. Chinese officials have stated that
they will allow the currency to appreciate. The only question here is the
pace of appreciation. Another aspect to look into is bank fees as these tend
to be high for yuan accounts.
The Chinese renminbi has appreciated by 3.3% against the
US dollar last year. Beijing loosened the currency's peg to the dollar during
summer. But the gains stalled after the world's major economies met in
November for the Group of 20 summit.
Chinese Demand for Gold
In a previous article, we have talked about the
increasing gold demand from China. This will impact global gold prices
because most will be imported. Right now, the premiums for gold bars for spot
delivery is skyrocketing and the end is not yet in sight. Some trends that
can be observed in China include rising food inflation and the rising levels
of general inflation. The phenomena may be the result of urbanization
shifting productivity from the countryside to the cities.
While inflation may play some part in rising demand for
gold in China, it is not the driving force behind it. As the country's
capacity continue to increase, its middle class investors are growing - many
of them are turning to bank deposits and gold because it is perceived to be
"safe". The government itself also has a massive demand for the
bullion.
Since we were just explaining how can events outside of
the US impact the price of gold, let's take a look at the long-term gold chart
from the non-USD perspective (courtesy of http://stockcharts.com):
 
From a non-USD perspective, the support is provided by the
200-day moving average, which has been important in the past. Please note
that even if this is a beginning of a bigger downswing, we are still likely
to retrace about 50% of the decline first, as it was the case previously.
Future of the Fed
Another notable concern that's worth mentioning this week
is about the future of the Federal Reserve. Questions about the Fed's ability
to withdraw stimulus money worth trillions of dollars are valid. This day
remains distant at this point but a number of economists are already thinking
about the unthinkable: can the world's most powerful central bank become
insolvent? Almost immediately, the answer is no.
As the United State's monetary authority, it can print
money at will. It has already bought $2 trillion worth of mortgage-backed
securities and the unorthodox steps it engaged in enabled it to generate
record profits in 2010. It sent $78.4 billion to the Treasury Department.
However, its swollen balance sheet leaves it exposed to credit losses at the
time of political encroachment on its independence.
But some experts worry that this exposure may force it to
"recapitalize" or basically ask for a bail-out. According to
Varadarajan Chari, an economics professor from the University of Minnesota as
well as a consultant to the Fed in Minneapolis, the Fed may go broke at some
point during its exit from current monetary positions - but just on paper. He
said that, "the most obvious exit strategy is, when the inflation starts
to pick up, to stop and reverse asset purchases." This might require to
Fed to incur significant accounting loss.
Thank you for reading.
Rosanne Lim
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