The shift from a US dollar dominant world to a multipolar one where the Chinese yuan is rising could provoke considerable geopolitical turmoil. For nations seeking to mitigate their risks, gold has much to offer, says Andrew Sheng

By Andrew Sheng*

The inclusion of the RMB in the IMF’s basket of international reserves signaled a coming of age for China’s currency. But it poses significant economic, financial and political questions.

Is the US dollar under threat as the world’s dominant reserve currency? Will there be a shift to a multicurrency reserve system? Will this affect geopolitical stability? And, if so, how can governments mitigate the resultant risk? For central banks in Asia, the answer might be gold.

The IMF’s basket of international reserves (known as the SDR) was initially designed to supplement member countries’ official reserves and, for the first 15 years of this century, its value was determined with reference to the US dollar, the yen, the euro, and the pound. In 2015, however, the RMB was added, a key indication of that currency’s increasing global influence.

Now, a working paper from the IMF3 has gone one stage further, tentatively identifying the formation of a RMB currency bloc, in addition to the dominant dollar reserve currency bloc and the euro currency bloc.

Excluding the RMB, the dollar bloc is clearly dominant in terms of GDP and usage. In terms of purchasing power parity (PPP), the dollar bloc accounted for about 60% of global GDP between 2011 and 2015. The euro accounted for 26%, sterling accounted for 7%, and the yen accounted for 5%.

If the RMB is included as a separate bloc, however, the world becomes much more multipolar. The dollar would account for 40% of global GDP, with the RMB at 30%, the euro at 20%, the yen at 5% and sterling at 3%. These figures suggest that the international monetary system (IMS) is already shifting from a bipolar focus on the dollar and the euro to a true, multipolar system.

PPP measures may overstate the influence of the RMB but there is little doubt that China is fast becoming the dominant economic force in today’s world. This has significant implications for the IMS and reserve currencies.

There are already signs that US debt levels have undermined the dollar’s status as the dominant reserve currency. The US is running a net investment liability to the rest of the world of around 40% of US GDP, financed by exceptionally low interest rates. This is increasingly unstable, particularly given that the euro- and RMB-bloc are both running current account surpluses.

As we move to a multipolar reserve currency system, therefore, certain steps will need to be taken to ensure the IMS remains fit for purpose. And gold could play an important role in this environment.

Today, the IMS relies on the dominance of the US dollar and the US has to run a current account deficit to supply the world with dollars. As we move to a multipolar system, that need should diminish. Ironically, however, the increasing importance of surplus economies, such as Europe, China and other Asian nations, has reinforced the dollar’s strength without alternative channels for surplus savings.

Among central banks, standard reserves portfolio management strategy calls for GDP or payment-weighted holdings of foreign exchange reserves. As the dollar accounts for 88% of all foreign exchange transactions, these surplus economies end up holding more dollars in their reserves, thus concentrating their risks in the dollar, rather than diversifying their risks.

The approach may seem short-sighted but it is perhaps inevitable, as there is no global central bank and no global fiscal policy. As a result, central banks and governments are forced to try and balance three, often conflicting, demands: portfolio management strategy, national risk management strategy, and global systemic stability.

This explains why dollar holdings in official reserves  have remained at roughly two-thirds of global total official reserves. Capital flows from emerging markets to developed countries have occurred because central banks and private investors have sought the liquidity and superior credit ratings only offered by the dominant reserve currency markets.

The inherent weakness of this ‘non-system’ is clear, however, which may explain why many emerging market central banks are increasing their allocation to gold. It is liquid and has neither credit nor default risk.

The former chairman of the US Federal Reserve, Alan Greenspan, has explicitly recognised this, publicly stating that gold is the ultimate insurance policy. The value of fiat currencies depends on their credit rating, fiscal health, and government or central bank policies. Gold requires no counterparty signature, does not depend on national fiscal or economic policy and is therefore the most effective hedge against geo-political risk.

Cyber currencies do not offer an appropriate alternative. Created by anonymous data miners, without counterparties or central registration, they are highly volatile and can expose investors to fraud, manipulation, and theft. Gold, by contrast, has a unique and diverse demand profile that makes it an ideal portfolio diversifier and a potential safe haven asset.

The inescapable conclusion is that the only viable alternative asset for official reserves is physical gold, as it alone has the requisite liquidity, correlation characteristics, and trust. Central banks seeking true risk diversification or insurance, therefore, should increase their gold holdings.

The argument is particularly apposite for China and India, the world’s largest consumers of gold. Yet today, China holds just 2.3% of its total reserves in gold, while India holds 5.8%. This compares to more than 60% in advanced economies such as the US, Germany, Italy, and France. Not only does it make strategic sense for China, India, and other surplus economies to increase their gold reserves; it also makes economic sense. Recent research commissioned by the World Gold Council suggests that, if central banks increase their gold holdings by 2%, 5% or even 10%, that can increase returns and reduce volatility over the medium and long term. As such, gold delivers distinct and notable benefits, increasing liquidity, reducing risk, bolstering returns and delivering true diversification from geo-political threats.

It is unlikely that the IMF will include gold in the SDR. However, if surplus economies, particularly large Asian nations, increase their gold holdings, this could pave the way for an IMS reform and simultaneously reduce geopolitical risk.

Such a move could be incrementally achieved if purchases were made with due consideration for medium- and long-term price stability. Indeed, if surplus economies adopted a more cooperative approach towards reserve management, it would have a marked and positive effect on the stability of the IMS.


Andrew Sheng is a Distinguished Fellow, Asia Global Institute, the University of Hong Kong. This article first appeared here.


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35 Comments

RBNZ has zero gold. The public just keep our nest egg in American stocks and NZ housing. Did we skip economics at school?
"Cyber currencies do not offer an appropriate alternative" another ignorant crypto denier. Gold is good as no counterparty but crypto is bad as no counter party duh! Fraud and theft is impossible with gold or fiat duh!
Talk about strawman arguments.

Gold and Bitcoin both have an advantage over fiat.

Any prudential saver or investor should have both.

Why the hell does an IOU from the internets have any value at all? Its just the new religion.

Not really, its the old libertarian religion dressed up in new clothes, ie dont have a central government reliance and hence dont have the Govn script..

Bitcoin like gold(if you hold in hand) and cash has no counterparty risk. This means you can spend at any time without asking someone for permission. If you went to the shops and found that your bank card is not working, you cannot buy anything. The counterparty ie bank has blocked your card or gone bankrupt. Bitcoin is the value what ever that maybe. Religion is based on stories. Bitcoin is based on rules enforced in code. Gold is shiny.

So the real counterparty risk is that the counterparty decides your digital IOU from the internet is worth its weight in gold.. ie, nothing.

bitcoin is nothing more than a digital IOU as opposed to a paper IOU it also needs backing.

If a bank has gone bankrupt and that with a monolithic risk economic profile this implies all banks have also gone (or about to go bankrupt) then the Q is does a Govn still exist? if it does than at least one bank will still exist (the Govn can and would create one) and hence its fiat currency has value as it is tradeable. If no Govn exists then there will also be no internet, no 3g/4g and hence bitcoin is un-verifiable also. Gold then? well you have to make sure even that is real.

But wait one moment, what you are them looking at is a mad max scenario. Where in effect society and the economy is gone, literally. What makes you think you can hang onto your gold? (or bitcoin?) with no one to keep the piece? good luck with that.

Bitcoin is not an iou.

you can exchange it directly p2p.

An iou is a deposit receipt.

And still buys absolutely nothing of value with it..... however people are very very happy to take your dollars, pounds, Yen and swap a bitcoing with you.....

It's this decades best con-trick.......... of course it will have value ....... see how I typed that with confidence.

Some really bizarre logical jumps there. You've basically concluded that one bank failing means that we've gone to mad max.

Fyi banks can exist without a government, and a government without banks. The existence of a bank also doesnt imply that fiat currencies can't lose 99% of their value.

You're seeing it in Venezuela now. Banks and government have dropped the ball, and the currency is toilet paper. They are close to mad max but the use of bitcoin and gold are very common. Even with a breakdown of central authority, people can find the means to trade with each other and get by.

How do the shops buy anything wholesale? ie where is the chain of trust that a functional fiat currency and centralised Govn implies that allows trade to happen?

I think you mean any libertarian should have both. Not quite sure why you think our RB should hold any as that measn there is more for you to possess, you should be happy with that.

Gold has what use day to day exactly? just about zero. If you want to hold a metal hold lead at least you can trade easily with it in a mad max world I assume you envision, or use it as needed.

PS The Govn's value is in what the country can produce, food which is 5 times what we need to consume ourselves.

Having watched both gold and now bitcoin implode I'd rather not thanks.

But physical gold has the fine quality of being able to be stashed under the mattress.
Unlike BitCoin, which can be be compromised by any ballon head with an internet connection.

I quite agree, if I was going to have to have one of either I'd go gold, never bitcoin but neither is my first choice.

Also lets say its an extreme event where you only have either gold or bitcoin. With gold you can physically go to the seller of food (say) and trade the gold for food. What guarantee do you have you or the seller have (and will continue to have) a functional internet connection so you can swap bitcoin in such an extreme scenario? I think not.

You can download the Bitcoin blockchain and transact via satellite - no internet required. Good luck getting change for your gold coins/bars. Nothing against gold, I like gold.

No internet required? What is at the other end of the satellite link? a single bitcoin server? how do you know its still part of the main blockchain and not a fork? Bitcoin requires working internet, absolutely.

Not between the merchant and the satellite.

lol, sending CNY up to a satellite

You get TV this way, why not currency?

They are conflating two separate issues.

You can sign a Bitcoin transaction and share it via paper, radio, wifi or morse code etc. However the Bitcoin network needs the internet to verify and confirm the transaction is valid and update the ledger.

In a world without the internet Bitcoin would not exist. Banking would go back 50 years to cheque's and telegraphic transfers https://www.investopedia.com/terms/t/telegraphic-transfer.asp
and Cash (notes/coins).

Originally money was coins of gold/silver. Over time paper notes were invented as a deposit receipt (iou for the guys above) of said gold/silver. America removed this link when they ran out of gold to pay for stuff. They now pay for stuff with printed paper or money created from debt(treasury's) .

The question is will the seller of goods you want accept the gold/bitcoin/paper/bank transfer you have available. The answer is maybe in all cases. If you had the last hamburger would you swap is for any amount of money, hell no.
All exchange of goods is dependent on the parties getting a value they desire. Who is to say how that value is stored. Government might try to coerce you to use one method over another but you still make the choice of your preference at the time that is in your best interest. Do you want to escape inflation, confiscation, fraud or just want something easy to convert. What you accept matters a lot for vendors and buyers.

And given the only place I've noticed in my travels that accepts crypto was a casino in Vegas.. says about it all really. I'm sure there are some, but when I roll into the gas station to fill up the car or go out for dinner , Cash, Visa/Amex, Eftpos are all useful, Gold and Crypto.. not so much.

The OP explained why the RB should hold gold.

It has no counterparty risk.
It is an unprintable store of wealth. Ie holds its value over time ( thousands of years). The USA, China and Russia hold gold for a reason and its not because its got no use....
They know that their currencies have gone to zero in recent history(fact).

You should read Currency Wars by Jim Rickards for a detailed explanation and a education on fiat currencies.

I love NZ and thinks it's special but it isn't immune to the human condition.

I agree.

Gordon Brown sold off all the UK's Gold before the credit crunch...... but only after announcing that the sale would be taking place, hence the price plummeted to around $230 an ounce........ if it were acceptable in the 21st Century to have people hanged, drawn and quartered for treason.... he would be second on my list, Tony Blair would be his warm up act! I'd probably finish the afternoon with Sir Fred the Shred Goodwin.... Actually no I'd keep him on ice and throw Mervyn King in for desert.... That would be a raucous afternoon outside the Tower! Bring them all in through traitors gate.

As for this article...... Yuan Yuan Yuan..... no chance... for an economy to function the existence of wealth has to be shared around more of the people so they all benefit... otherwise all you have is risk of revolution...which is why all the money has been flying out of the country,,, ever had enough of working 60 -70 hours a week making I-phones when it would take you 6 months to earn enough to pay for one???

In the new media age I'd give the current debt fuelled system in China around 5-10 years before an uprising........... Other options are they remain happy winning more gold medals in the Olympics but living in cardboard houses.... or they start invading places and giving the massive population of men (remember how the one child policy that has operated since 1979) some opportunity to move abroad by force and find someone to play with......

Yuan Yuan Yuan..... I've stopped buying Chinese stuff.

Nic,

Gordon Brown sold off approx. 50% of the UK's gold reserves-395 tonnes. I agree that made no sense,but for all his many failings-a failure as PM-he deserves enormous credit for keeping the UK out of the Euro with his 5 tests. I am with you on Blair and Goodwin, but what did Mervyn King do deserve such a fate?

Personally I dont agree, it has no functional place.

Well, no currencies I know of are backed by gold. Best that countries start backing their currencies with some kind of commodity. Personally I'd rather transact in Bitcoin and will be doing more so as merchant adoption increases.

Unless countries back their currencies by gold or some other commodity, countries risk their currencies becoming worthless as more and more of their citizens dump their respective 'national currency' in favor of Bitcoin. Governments will be hated for demanding taxes be paid in fiat.

Eventually countries with currencies not backed by gold will find their governments don't even want their national currencies. Currencies fail all the time, the difference is now citizens aren't trapped, they can, will and are dumping their failing currencies in favor of Bitcoin.

Chinese columnist claims Chinese dominance is assured. More news at 11.

A deeply flawed column which is based on a cherry picked, and irrelevant, data point that is intended to paint China in the strongest possible light. What does GDP have to do with the composition of currency reserves?

IMF figures show that in Q1 2018, US dollar holdings made up $6.5 trillion out of a total of $11.6 trillion worldwide. RMB made up $145 billion. Even the pound made up $487 billion. RMB remains the political plaything of the Chinese Communist Party and anyone who seriously thinks it will become the world’s main store of value any time soon is quite honestly crackers.

Go am_fek. If anyone believes the Yuan is worth anything outside of China then they're silly.
The only Chinese who have anything have got their money out of China and bought up real estate in the worlds most livable English speaking cities. Their businesses rely totally on the Americans buying their cheap stuff for American dollars. Sure, they're going to be a factor in tomorrows world, but they still cheat and can't be trusted even inside China. Mr Xi said in 2015 that the South China Sea would not be used for military purposes and has spend day and night since militarianising them. They simply cannot be trusted. And neither can their currencies. Mr Han will be gold-digging (again) shortly.

Careful. We don't want to scare the herd.

The US lost economic power when they decided to hand over their manufacturing jobs to China at least a decade ago. America is now the biggest consumer of goods on the planet and yet they no longer produce anything much these days. While the average american now just consumes everything for a cheap price, they have also lost most of their jobs to pay for their cheap purchases from China. The end game is now that China owns and manufactures everything while the fat american consumer no longer has the skills to compete, let alone survive on their own. They sold off their silver for pennies in the dollar and are now eating with their own hands. New Zealand is more economically tied to China these days, as is Australia. Watch out, because we may soon find ourselves having to decide who to side with if these Trade Wars end up in a real war. Do we side with China and Russia this time?? Food for thought.

The US has a habit of making a comeback when all seems lost. It is part of their mythology about themselves. This article is a thoughtful one, they are trying to figure out where things went wrong. They have to go all the way back to Reagan to find someone who had any idea about what mattered.
https://www.zerohedge.com/news/2018-07-06/pat-buchanan-never-trumpers-ar...

Jim Rickards made a plausible case that the SDR, if it were to be even partially backed by gold, would result in a non-deflationary price of around ~10,000 USD per ounce. Until Armageddon hits, gold holding seems to present quite a high opportunity cost, given it's price is so suppressed relative to other assets. Worth while bearing in mind that the total market cap of gold is only about 7-8 trillion usd.

GOLD = hedge play on inflation and turmoil in world politics. Does not pay dividends and many ignore it for this reason alone. Just ask Buffet. Jim Rickards part of the gloom and doom trio consisting of Rickards, Grant, Rogers and Peter Schiff ( well more then a trio ) have been recommending this for years. Yes I do believe it should be part of any portfolio but only as a hedge on inflation like any other commodity. Gains in the last 7 years have been flat= inflation dismal. 5-10% in portfolio max.

https://www.bullionvault.com/gold-price-chart.do

As soon as I saw people swapping real money for Bitcoin I think the game was up for me. So basically Bitcoin is creating something out of nothing and selling it for real dollars. Its value going forward from there is one of pure speculation. Doesn't really sit well with anyone with a sense of logic.