Needless to say, throughout the turmoil of the last year, the forecasts for most asset classes have been bearish. However, many speculators have been bullish on China and gold, largely because of what’s happening in the rest of the world. Indeed, many of those who predicted the crash—such as Jim Rogers and Peter Schiff—argue China and Gold are the only safe assets to hold over the next couple years. Maybe the futures of these two are more related than it seems.
China seems to be doing great. The latest economic figures on housing, auto sales, and commodities are quite good. Goldman Sachs recently upgraded growth forecasts for 2009 to 8.3% from 6% and, for 2010, to 10.9% from 9%. And, best of all, new loans in March were 29.8% higher than a year earlier!
I wrote in my last post on the question whether, “horses will drink,” a reference to the question whether increasing the money supply will increase the velocity of money. China doesn’t have that problem. While the US can encourage banks to lend and use TARP money to make loans (most haven’t), China only needs to say the word, and it’s done—one of the benefits of an authoritarian government.
But is this really a benefit? It seems so in the short run, but in the long run it can mean losses from sloppy lending, especially in a country with crony capitalism. A lot therefore depends on the much-asked question whether China can survive without strong exports. Economists are divided on the issue. There is data that shows only 8% of China’s workforce is involved in export industries. Either way, it is hard to imagine how China could keep up its growth without external demand and capital at current levels of domestic spending. For that reason, much depends on Chinese consumer spending. James Kynge wrote in his famous book China Shakes the World in early 2006 that Chinese consumer spending should “hit us in two or three years.” The world, as well as the largest shopping mall in the world in Dongguan—nearly empty, is still waiting.
People’s Bank of China governor Zhou Xiaochuan recently gave a speech on China’s “superior system advantage.” In it he argued the country’s low interest rates, stimulus, and new medical system will boost domestic spending and bring China, and the world, out of recession. The health service plan is seen as a key part of boosting consumption. Chinese generally save at much higher rates than the rest of the world. Many think the higher savings rate is a result of uncertainty about the future, and that a social safety net would greatly increase consumer spending. While this may be so, China’s new health care system will not function for many, many years. So of these three variables Zhou Xiaochuan mentioned, only one has a substantial effect of raising consumer demand and it will not be in effect for years.
The government must, therefore, rely on itself. It must spend its way to economic growth, and though its reserves are vast, it may be more limited than it seems. Zhou Xiaochuan has been in the news recently after calling for a new reserve currency from the IMF, echoing Premier Wen Jiabao’s call for guarantees on China’s dollar holdings. And for good reason: China is in a sticky situation with its dollar assets. In the short term, selling treasuries would drive down the price of treasuries, raising interest rates and hurt Chinese exports even more by raising the value of its currency. In the long term, inflation in the US could wipe out their value. China is treading a thin line between stimulating its consumers and hurting its exports. For that reason, China needs a new reserve strategy.
One option is gold. In fact, the FT reported a few days ago China’s gold reserves had jumped drastically to 1,054 metric tons. The dramatic shift is evident in the graph below, which is from before its acquisitions were public. China's true holdings should be around those of Switzerland.
Of course, gold could never replace the dollar as China’s main reserve asset. China is a lot more important to gold than gold is to China. Gold has been struggling to stay high after the fear frenzy of the stock market crash burned down. If China decides to put more emphasis on gold, which is likely considering its problem of holding too many dollars, gold could rise above $1,000 per oz, much like China did for copper earlier this year.
