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Song Xin: Increase Gold Reserves And Join SDR.

The Chairman of the China Gold Association and General Manager and Party Committee Secretary of China National Gold Group Corporation, the latter being China’s largest gold mining enterprise, is Song Xin and happens to be one of my favorite commentators in China. This gentleman made waves in July 2014 when he candidly wrote on Sina Finance that the People’ Bank Of China (PBOC) should slowly raise its official gold reserves to 8,500 tonnes, more than what the US Treasury claims to hold. The article was published in Chinese but translated by BullionStar to share the views by Song Xin with the English speaking world:

For China, gold’s strategic mission lies in the support of renminbi internationalization, and so let China become a world economic power and make sure that the China Dream is realized. … gold forms the very material basis for modern fiat currencies. 

Gold is the world’s only monetary asset that has no counter party risk…

That is why, in order for gold to fulfill its destined mission, we must raise our gold holdings a great deal, and do so with a solid plan. Step one should take us to the 4,000 tonnes mark, more than Germany and become number two in the world, next, we should increase step by step towards 8,500 tonnes, more than the US.

In the next translation further below you will read more on how Song Xin views gold’s role in China’s financial strategy. The bullet points from the article:

  • China continuously accumulates gold reserves to support and accelerate renminbi internationalization.
  • Renminbi confidence and gold are closely related. Gold reserves are the cornerstone for renminbi internationalization.
  • In modern times gold plays an important role in managing economic risk and maintaining China’s financial safety.
  • China is continuously increasing its official gold reserves in conjunction to joining the SDR.
  • The ratio of China’s official gold reserves to its GDP should be more in line with the US and other developed countries. At this moment China’s official gold reserves are still relatively low.
  • The Silk Road economic project, also called “One Belt and One Road” (OBOR), has huge development opportunities for the Chinese gold industry. Song Xin mentions that the in ground gold reserves of countries along OBOR reach 21,000 tonnes. In 2015, witnessed by Chairman Xi Jinping and President Putin, China National Gold Group Corporation and Russia’s largest gold mine Polyus have signed a strategic cooperative agreement and they are promoting detailed relevant cooperative issues at present.

What he didn’t mention is that China is striving to boost gold trade along OBOR to be settled in renminbi through the Shanghai International Gold Exchange.

Is The SDR A Means Or And End For China? 

In the mainstream media we often read China wants the SDR to replace the US dollar as the world reserve currency, based on statements from PBOC Governor Zhou Xiaochuan – among others:

Special consideration should be given to giving the SDR a greater role. The SDR has the features and potential to act as a super-sovereign reserve currency.

Since 2009 China has vigorously pressured the IMF for renminbi inclusion into the SDR. Finally, in 2015 the IMF decided the renminbi would be added to its currency basket in October 2016.

Zhou and other prominent economists at the PBOC are clearly pushing the SDR, but what’s China’s exact strategy?

In advance of the official inclusion of the renminbi into the SDR, which will take place on October 1, 2016, developments regarding the International Monetary Fund’s synthetic reserve currency are unfolding rapidly.

Author of the Big Reset, Willem Middelkoop, reported this August a “Substitution Fund” is being discussed in the higher echelons of the monetary elites, to facilitate dollar exchange for SDRs outside the market, and thus creating an escape from dollar reserves without putting downward pressure on the dollar.

Also in August, The PBOC allowed a division of the World Bank (the IBRD) to issue bonds denominated in SDRs in the Chinese market. The bonds worth $2.79 billion dollars can be created “soon” – presumably within a month. In addition, the Chinese government-linked China Development Bank will issue SDR notes worth somewhere in between $300 million to $800 million dollars. Both issues are “SDR-denominated financial market instruments” called M-SDRs by the IMF. Though experts think the M-SDRs will encounter many practical challenges when implemented and demand will be tepid, nevertheless the intention by the PBOC to launch these instruments is clear.

On the surface we can observe China has a vast interest in the SDR, but is the SDR a means or an end for China? What if China is simply using the SDR as a vehicle to achieve other objectives? For example:

  1. Dethroning the dollar. The SDR can be an excellent tool to unwind the dollar hegemony. In addition the Substitution Fund could help an orderly exit from China’s lob-sided dollar reserves.
  2. Internationalize the renminbi. Inclusion of the renminbi into the SDR boosts global renminbi acceptance as a reserve currency.
  3. Reduce capital outflows from China. With respect to M-SDRs, David Marsh of financial think tank the Official Monetary and Financial Institutions Forum (OMFIF) wrote:

Beijing’s SDR capital market initiative will allow domestic Chinese investors to subscribe to domestic bond issues with a significant foreign currency component, which will help dampen capital outflows… 

I think for China the SDR is just a means to an end. The end being to internationalize the renminbi, which of course is connected to the dollars retreat. And as Song Xin clearly states, “gold forms the very material basis for modern fiat currencies” and, “gold reserves should become the cornerstone … for renminbi internationalization”.

In my humble opinion the financial crisis has shown (once again) the inherent flaws of all fiat currencies. A bundle of some of these currencies will not solve the problems ahead of us; at best provide tools or a next level printing press. I still prefer gold as a store of value.

I find it interesting that Song Xin mentions the importance of the ratio between China’s official gold reserves and GDP. This concept was also brought forward by Jim Rickards. If the PBOC would have 5,000 tonnes of official gold reserves their “gold to GDP ratio” would be roughly on par with to the US, Europe and Russia.  One of the theories about our current international monetary system – that was detached from gold in 1971 – is that it can shift to a new gold anchored system when the power blocks have equalized the chips (Jim Rickards). In other words, if the US, Europe, Russia and China all have a roughly equal ratio of official gold reserves to their GDP, the international monetary system could make a transition towards gold.

Global gold vs GDP

According to my estimates the PBOC has roughly 4,000 tonnes in official gold reserves, in contrast to what is publicly disclosed at 1,800 tonnes. Perhaps the PBOC is “nearly there”.

Song Xin who was also a speaker at the “Renminbi Internationalization and China’s Gold Strategy Seminar” in Beijing on 18 September 2015.

Original source of the article below is the China Gold Association website. [Brackets added by Koos Jansen]

Song Xin, Chairman of the China Gold Association, General Manager and Party Committee Secretary of the China National Gold Group Corporation: Stick to the gold mission and boost innovative development

March 14, 2016

As the sole central enterprise in the gold industry, China National Gold Group Corporation is a firm defender of renminbi internationalization, pioneering demonstrator of the country’s “One Belt and One Road”, and faithful guardian of a happy life for people. It’s the direction that we should strive for.

On March 10 during the two assemblies, Song Xin, Chairman of the China Gold Association, General Manager and Party Committee Secretary of the China National Gold Group Corporation, was the guest in Xinhuanet’s 2016 two assemblies special Interview. In the program Dialogue with New State-owned Enterprises and Cheer up in the “13th Five-Year Plan”, he proposed the conclusions above. Besides, in the in-depth dialogue, Song Xin systematically illustrated topics including the functions of renminbi internationalization, effectively enhancing gold supply, realizing improved quality and efficiency of enterprises, practicing the central party’s “Five Development Theories”, and fulfilling the responsibilities of central enterprises.

About Gold’s Functions: Increase Gold Reserves And Accelerate Renminbi Internationalization. A Close Relationship between Increasing Gold Reserves And Joining The SDR

When the credit lines of paper currency declines and there are enough gold reserves, people can be less worried about the existing credit system and enhance their confidence in the currency.

Last year, China joined the IMF (International Monetary Fund) Special Drawing Rights (SDR), signifying the renminbi’s march towards internationalization.

Song Xin pointed out that the renminbi is closely related to gold. Gold is priced in US dollars throughout the world and in renminbi in China. There is a special relation between the renminbi and gold. We have continuously increased gold reserves since China strove to join the SDR basket of currencies. By the end of February this year, our gold reserves have increased to 1788.45 tonnes. In other words, China has continuously increased its official gold reserves and publicized the amount to the world, keeping a close relation with renminbi internationalization and joining the SDR.

Song Xin 2016:07:26

Further increase gold reserves to adapt to economic strength

China’s existing gold reserves are only about 1/5 of America’s. With the acceleration of renminbi internationalization, the renminbi should further increase its gold reserves in order to reach a level matching the national economic aggregate [GDP], especially if the renminbi wants to become a global currency.

Song Xin mentioned that China’s gold reserves once maintained around 1,054 tons. In the second half of last year, it started to increase these reserves substantially. Now, it has been increased by 70%. The increase range is big, but small compared to that of developed countries. At present, our economic aggregate [GDP] reaches second place in the world, but our gold reserves only reach the sixth place in the world. If the IMF’s reserves are excluded, China’s reserves rank in fifth place according to national rankings.

Possessing sufficient gold can strengthen confidence in a currency

Song Xin said, “There is a remarkable distance between China’s gold reserves and America’s gold reserves. America’s gold reserves are 8,133 tons and it even reached over 20,000 tons before. In those days, America controlled most of the gold in the world, which laid an important foundation for the US dollars to become a global currency.”

Before the Bretton Woods system was disintegrated in the 1970s, gold was directly connected with the US dollar. After the Bretton Woods system was corrupted, gold was disconnected from the US dollar, but America still kept sufficient gold reserves.

Song Xin believes that it has a relation with the global governing system. When the global economic aggregate was not so big, the gold standard had a certain advantage. With the expansion of the economic aggregate, the Bretton Woods system was disintegrated, and gold was disconnected from the US dollar. America announced that gold was unimportant then under this circumstance. However, in fact, when a financial crisis happens in America, its gold reserves don’t reduce at all. Americans firmed up people’s confidence in the US dollar by sufficient gold reserves.

Talk about supply reform: increase the effective supply of gold to boost quality and efficiency of enterprises rather than excess capacity, the gold industry needs to increase supply

In 2015, our domestic gold mine output reached about 450 tons, ranking the top in the world for nine consecutive years. Meanwhile, gold [retail] consumption reached almost 986 tons, surpassing India for three consecutive years and becoming the largest gold consumption country in the world.

Song Xin mentioned that our gold production can’t satisfy consumption demand and it doesn’t include the central bank’s reserves. Therefore, for the gold industry, increasing gold production and rapidly supplementing the gap above are the important missions for the gold industry.

Regarding how to increase the effective supply of gold, Song Xin believes that enterprises in the gold industry should offer more suitable marketing paths, especially customers’ favorite gold jewelries and gold investments with cultural connotation and innovation.

Maintain national financial safety and fulfill political responsibility 

“The political responsibility of the China National Gold Group Corporation is to make enterprises strong, excellent and big. Besides that, it is also to allow staff to enjoy the achievement of enterprise development. More importantly, it is to increase the effective supply of gold, to satisfy the demands of people and country for gold products, and to maintain the healthy and harmonious development of the industry”, said Song Xin.

Song Xin introduced that gold played a very important role in different historical periods. In the revolutionary war period, the underground party delivered abundant gold to Yan’an from the Jiaodong base area in order to get medicine and materials, playing a positive role for the Communist Party to gain victory. In the beginning of reform and opening up, the country’s foreign exchange was in a shortage and our country vigorously increased gold productivity, once amounting to 70% of the whole country’s foreign exchange reserve which is mainly for gold swap transactions and purchasing devices, etc. and guaranteeing foreign exchange demand of economic development. In the new era, gold has played an important role in resisting economic risk, maintaining the country’s financial safety and assisting with renminbi internationalization.

Song Xin thinks that the China National Gold Group Corporation shoulders the important mission of increasing gold reserves and production and adding trust for renminbi internationalization for the country. He said, “Gold reserves should become the cornerstone or ballasting stone for renminbi internationalization, which can improve the gold content of renminbi. In these aspects, the China National Gold Group Corporation is obligated to fulfill its own political duty.”

Chinese historic gold mining 1949 - 2015

Talk about “Five Major Development Concepts”: Explore Profound Meaning Based on Practical Conditions for Enterprise.

Make achievement in the “One Belt and One Road”

With the implementation of “One Belt and One Road”, the China National Gold Group Corporation can accomplish a lot in “going out” and “going out” is an important constituent of our reform and opening up in the new era. “One Belt and One Road” has brought huge development opportunity for Chinese gold industry and enterprises. Song Xin mentioned that the gold [in ground] resources of countries along the “One Belt and One Road” reached 21,000 tons, taking up 41.5% in the world. The gold production of countries along the line reached 1,116 tons, occupying 1/3 in the world. In addition, 6 gold mines are located here among top 20 gold mines in the world.

“The consumption amount of gold jewelry in the area accounts for 82.4% of the global consumption amount. Physical gold item demand including gold bars takes up 77% of the global demand. Gold resource development potential and gold market consumption potential in the area are quite huge, bringing important strategic opportunities for Chinese gold enterprises”, he said.

Song Xin introduced that the China National Gold Group Corporation is constructing mines in Kyrgyzstan and Congo. Last year, witnessed by Chairman Xi Jinping and President Putin, China National Gold Group Corporation and the largest Russian gold enterprise have signed a strategic cooperative agreement and they are promoting detailed relevant cooperative issues at present. Meanwhile, they are preparing to export devices to countries along the “One Belt and One Road” including Russia and Kazakhstan. In the practice of open concept, China National Gold Group Corporation is comprehensive and systematical.

Analyzing PBOC Official Gold Reserves Increment

As always, please make sure you’ve read The Mechanics Of The Chinese Domestic Gold Market before continuing.

Finally last Friday the People’s Bank Of China (PBOC) updated its official gold reserves, from 1,054 tonnes, a figure reported since 2009, to 1,658 tonnes. Most gold analysts expected a number substantially higher than what was just disclosed. In this post we’ll analyze the 1,658 tonnes figure.

Before diving into the analysis, I like to share that I think it’s possible the PBOC hasn’t been completely honest by stating their gold reserves have grown by only 604 tonnes since 2009. I think in reality they have more than 1,658 tonnes, but let’s discuss that later on. In my analysis, I always try to start with official data and work my way from there, instead of start with speculative data and work backwards. It’s very easy in the gold space to rebut all official data, mainly because there is so much speculation. Therefor, I would like to start with the figure just disclosed, then I’ll try to answer, why 1,658 tonnes?

PBOC Gold Reserves Increment Was Covertly Imported

With regard to the update in gold reserves, the PBOC has stated on its website (in Chinese):

Based on our assessment of the asset value of gold and analysis of price movements, on the condition of not impacting or influencing the market, through various domestic and international channels, we gradually accumulated this part of gold reserves. The major channels of accumulation include: purifying domestic gold scraps and gold of various grades [杂金 in Chinese usually means non-standard gold including scraps so I have to paraphrase it], direct purchase of production, transaction in domestic and foreign markets, etc.   

The official narrative is that the PBOC has bought 604 tonnes of gold in the domestic and international market. From my perspective, however, I think the PBOC has mainly been buying gold in the international market, as that’s where superfluous US dollars can be exchanged for gold. In the Chinese domestic gold market, physical gold is settled in renminbi. Gold the PBOC potentially has obtained in the mainland would be from state owned mines that not sell their gold through the Shanghai Gold Exchange, but have the gold directly transported to central bank vaults.

Not so long ago I wrote a lengthy post on PBOC gold reserves, it was titled PBOC Gold Purchases: Separating Facts from SpeculationThe article contained a few concepts I still believe in:

  • The PBOC does not buy gold through the Shanghai Gold Exchange (SGE).
  • PBOC purchases/shipments are not disclosed in global customs reports.
  • As a consequence, everything we can see going into China (exports from other countries to China which are required to be sold through the SGE) and domestic mine supply (which is mainly sold through the SGE) are being added to private gold reserves and does not end up at PBOC vaults.

According to the China Gold Association (and global trade data), mainland net gold imports from 2010 until 2014 accounted for 3,967 tonnes and domestic mining output over this period totaled 1,979 tonnes; a combined 5,964 tonnes.

To summarize we know that:

(1) Laws and tax incentives direct Chinese gold import and gold mine supply to be sold through the Shanghai Gold Exchange

(2) Chinese private gold demand is all supplied through the SGE

(3) Physical gold at the SGE can only be settled in renminbi

4) The PBOC is likely to buy gold abroad with US dollars (not renminbi) to diversify their lopsided FX reserves and

(5) In 2014 an SGE official confirmed that the PBOC did not buy gold through the Shanghai gold bourse

With this knowledge, it’s easy to understand the PBOC did not buy the 5,964 tonnes of gold that was supplied to China 2010-2014 through import and mining. The 5,964 tonnes was consumed by private gold buyers at the Shanghai Gold Exchange. To repeat myself, PBOC gold purchases cannot be traced from global trade data or SGE withdrawals, as these occur in the realm of the private Chinese gold market.

One more reason why the gold exports to China we can see – for example in Hong Kong customs reports – are not addressed by the PBOC is that it can be observed  that gold bullion is being declared as either non-monetary or monetary gold when studying customs data from any country. If the PBOC can choose how to declare their bullion, they’ll choose monetary. These are typically the options available when making a gold customs reporting:

  • Gold, for non-monetary purposes (HS code 71081100)
  • Gold, unwrought, for non-monetary purposes (HS code 71081200)
  • Gold, in semi-manufactured forms, for non-monetary purposes (HS code 71081300)
  • Monetary gold (HS code 71082000)

The essential difference between these four categories is that “monetary gold” is always blank; this category is never disclosed publicly! As we know, the PBOC prefers to buy gold in secret, so their gold transport surely is hidden in the eclipsed category “monetary gold”. It’s thus pointless to try to measure PBOC gold reserves from available customs data on gold, as this data doesn’t show gold monetary shipments. From trade data we can only see what’s entering China for private gold demand sold through the SGE.

From this perspective all official gold data presented above makes sense; all these thousands of tonnes of gold we could see entering China fell into the hands of private hoarders.

My supposition can be further strengthened if we re-read translations from Chinese gold industry officials I’ve published over the years. From Sun Zhaoxue, President of the China Gold Association in 2012:

We should advocate to ‘store gold among the people’ and guide a healthy positive development in this segment. In recent years, the domestic gold industry’s rapid growth provided good conditions for various uses of gold, as well as create space for this business to grow faster. China … has to catch the opportunity, while increasing its supply capacity, to push the ‘store gold among people’ strategy, actively extend the business value chain, increase gold investment types, encourage and promote individuals’ gold investment and consumption. Foremost, maximize the utilization of … gold retailers, increase sales channels, optimize sales network, strengthen branding and achieve to ‘store gold among the people’ and thus ‘store wealth among the people’. This is the objective under our gold strategy.

From an internal memo (only published in Chinese) from the PBOC on how to develop the gold market, 2012:

The tradition of gold investment and consumption is with our people/citizens. As the private sector grows at speed and living standard upgrades, private demands for gold jewelry, coins and investment gold are also growing quickly. A gold market with a rich diversity of products will help develop new investment channels, satisfy the varied demand, help investors make appropriate asset allocations, raise investment returns and protect our wealth assets.

There have been many clues the PBOC was buying gold as well, next to Chinese private demand, but for now we’re confirmed the gold we could see going into China over the years has been from the private sector.

Let’s make a new chart:

Estimated Total Chinese Gold Reserves (July, 2015)

I’ve accumulated all domestic gold mining output and known gold imports isolated from “Official reserves” since 2009. The “Official reserves” increments in 2001 and 2003 are subtracted from “Cumulative domestic mining”, the “Official reserves” increments in 2009 and 2015 are not subtracted from “Cumulative domestic mining” or “Cumulative total import”, as my theory is that this was covertly imported. A detailed description of how I compiled this chart can be found in my previous post on this subject.

If I’m right in my analysis that the PBOC has mainly been buying gold abroad since 2009, there are currently 13,781 tonnes of gold in China, of which 1,658 tonnes are (confirmed) official gold reserves and 12,123 tonnes are private reserves. Needless to say, everything the PBOC potentially holds in addition to 1,658 tonnes official reserves must added to these estimates. (I do not rule out the PBOC is able to buy gold in the domestic market.)

PBOC Gold Reserve Increment Is A Strategic Move

The PBOC’s decision to disclose their official gold reserves at 1,658 tonnes cannot be viewed in isolation from global monetary affairs. Since the financial crisis in 2008, Europe and Asia have been very clear in their preference to gradually decrease the emphasis of the US dollar as reserve currency in the international monetary system. China’s strategy is to play multiple hands at the same time of which one is the SDR.

For the development of their economy, China aims to internationalize the renminbi. The composition of the SDR will be reviewed later this year. A requirement for a currency to be included in the SDR is that it’s freely usable. China will thus be required to disclose its reserves at least once yearly by groups of currencies. If we read the official statement on the gold reserves by the PBOC in Chinese, this is apparent from the part containing info about IMF’s Special Data Dissemination Standard (reserves disclosure).

With the US having the power to obstruct renminbi inclusion into the SDR, the Chinese have to play it safe. They are required to be transparent about their true gold reserves, but may not want to upset the US by disclosing an official gold reserve figure at 3,500 tonnes. The 1,658 tonnes figure, which is too little to rock the global financial order, though a sign that China assesses gold to be “an important element of international reserve diversification” may thus be an appropriate figure. It’s not in China’s interest to rush into a new international monetary system as they continue to diversify away from the US Dollar.

China UST holdings

From the above chart, we can see China is not net selling US treasuries, but that they have stopped increasing their accumulated holdings since 2010. The Chinese aren’t ready for a major shift in the international monetary system yet. They are still working on further internationalization of the renminbi, the SDR inclusion, developing their financial markets and opening up their capital account. Only then will they unwind the US dollar. Until then, China will continue to adopt a slow step by step approach.

Will The Shanghai International Gold Exchange Facilitate Gold Inclusion Into The SDR?

The Shanghai International Gold Exchange (SGEI) was launched in September 2014, to internationalize the Chinese gold market and the renminbi. The timing of the launch is quite remarkable though, in the context of changes in the international monetary system (IMS).

2015 is likely to force a major shift in the IMS. Two developments are worth watching, the SDR basket will be reviewed, the renminbi will probably be adopted later this year, and the rise of the Asian Infrastructure Investment Bank (AIIB), an international financial institution proposed by China with many Western members; currently France, Germany, Italy, Luxembourg, Switzerland, New Zealand and the UK. Both developments are severe blows to the US dollar hegemony.

Last week I reported on, (i) the IMF terms for the renminbi to be adopted into the SDR, (ii) if these terms can be met this year, and (iii) what the role of gold will be in the process (read China, Gold, SDRs And The Future Of The International Monetary System). Since then there has been more confirmation of renminbi adoption in the media.

From Reuters:

China’s yuan at some point would be incorporated in the International Monetary Fund’s Special Drawing Right (SDR) currency basket, IMF Managing Director Christine Lagarde said, …”It’s not a question of if, it’s a question of when,”

From Xinhua:

China and Germany conducted their first high-level financial dialogue here on Tuesday and agreed to strengthen macro-economic policy coordination

…confronted with a complex and fragile global economic situation, China and Germany as important economies should strengthen policy coordination, coordinate strategic cooperation, deepen financial and fiscal cooperation…

Representing Germany at the dialogue, German Finance Minister Wolfgang Schaeuble and Deutsche Bundesbank President Jens Weidmann said that Germany and China have been working together very well both bilaterally and multilaterally in financial and fiscal areas…

According to a joint statement after the dialogue, the German side will actively support … China’s goal to add the RMB to the special drawing rights (SDR) currency basket based on existing criteria.

…During the dialogue, both sides reached consensus on issues such as investment cooperation between China and Europe, China and Germany and in third countries.

Kindly note, Germany officially has the second largest gold reserves in the world and are currently repatriating gold from the US. Thereby expressing their affinity with gold and their lack of trust in the US as their custodian. This Germany would like the renminbi to be included into the SDR.

The most important condition for the adoption of the renminbi is that it must be freely usable. From Criteria for Broadening the SDR Currency Basket, an IMF paper published in 2011, “that discusses a number of reform options for the eligibility criteria for the SDR currency basket”:

The freely usable concept and its two key elements—currencies should be “widely used” and “widely traded” —are set out in the Articles and serve important operational purposes.

The renminbi is currently “widely used” and “widely traded”.

Will Gold Be Included In The SDR Basket? 

China gold x

The reason the current IMS is up for revision is because the global fiat experiment has failed miserably. Having exclusively fiat currencies circulating within countries, without any anchor to a non-fiat reserve currency, is simply not sustainable. In shaping a new IMS the designers would be mistaken to create a system based on a basket of solely fiat currencies, which have just proven to be ineffectual. Gold could provide credibility and strength to the SDR.

In addition, we could read some clues (in my prior post) that the Chinese would like gold in the SDR along side the national fiat currencies. This would explain China’s aggressive gold purchases in recent years.

On March 9, 2015, Albert Cheng, managing director of the World Gold Council Far East, was interviewed by ShanghaiDaily.com:

Q: The council has signed an understanding agreement with the Shanghai Gold Exchange to work more closely via the International Board set up in the city’s pilot Free Trade Zone last September. Could you tell us how that will work?

A: The memorandum of understanding involves objectives to improve operation of the Shanghai Gold Exchange, such as attracting more international players. Gold is a hard currency, so if it is freely traded in China, it will have an impact on the yuan. The design of the International Board, allowing international and domestic investors to participate in the onshore gold market, has a symbolic meaning of some kind of convertibility. By signing the memorandum, we can help the Board marketing this concept to the international trading community.

In general the renminbi is not yet fully convertible, but in terms of gold it is; through the Shanghai International Gold Exchange. Logically all currencies in the SDR basket must be freely usable, and allowed to be freely exchanged for one another. If the renminbi and gold were to be added to the SDR basket it would help if there is an exchange for both, which is currently operating in the Shanghai Free Trade Zone.

Will the Shanghai International Gold Exchange facilitate gold inclusion into the SDR?

China, Gold, SDRs And The Future Of The International Monetary System

Possibly China’s national currency will be part of the IMF’s Special Drawing Rights (SDR) this year. If so, this would have substantial implications for the international monetary system.

Currently the SDR, which was invented in 1969 right after the London Gold Pool collapsed, consists of US dollars (41.9 %), Euros (37.4 %), Pound sterling (11.3 %) and the Japanese yen (9.4%). The weights assigned to each currency in the SDR are adjusted to take into account their prominence in terms of international trade and national foreign exchange reserves.

China has been interested in SDRs at least since the seventies, but became more outspoken in 2009, when Zhou Xiaochuan, Governor of the People’s Bank of China (PBOC), called for replacement of the US dollar as the world reserve currency by the SDR as to achieve the objective of safeguarding global economic and financial stability. China is currently the second largest economy in the world and its wishes can ultimately not be denied by other major economies. From Zhou:

… the role of the SDR has not been put into full play due to limitations on its allocation and the scope of its uses. However, it serves as the light in the tunnel for the reform of the international monetary system.

A super-sovereign reserve currency not only eliminates the inherent risks of credit based sovereign currency, but also makes it possible to manage global liquidity.

Special consideration should be given to giving the SDR a greater role. The SDR has the features and potential to act as a super-sovereign reserve currency.

Further improve the valuation and allocation of the SDR. The basket of currencies forming the basis for SDR valuation should be expanded to include currencies of all major economies, and the GDP may also be included as a weight. The allocation of the SDR can be shifted from a purely calculation-based system to a system backed by real assets, such as a reserve pool, to further boost market confidence in its value.

More present, on March 12, 2015, PBOC official Yi Gang said he’s “actively communicating” with the IMF on including the renminbi in the basket of the SDR.

We hope the IMF can fully take into account the progress of renminbi internationalization, to include the renminbi into the basket underlining the SDR in foreseeable, near future.

It should be noted the IMF and the PBOC started communicating long before 2015. For example; since 2013, every year in March, the IMF and the PBOC hold a joint conference in Beijing on “…new issues in monetary policy in an international context and assess their relevance for China. Against the backdrop of the global financial crisis and the use of unconventional monetary policy, it will look at the implications for monetary policy frameworks, as well as the changing toolkit of central banks.” The conference brings together international experts, Chinese academics, PBOC and IMF staff.

Click here for the full transcripts of the 2013 conference, here for the 2014, and here for the March 16, 2015, program.

One of the speakers at the 2014 conference was Dr. Wang Yu, Deputy Director General, Bureau of Research at the PBOC. His biography states:

During his tenure at the People’s Bank of China, Dr. Wang participated in the creation of China’s monetary policy framework and the building of the Chinese financial market. He is involved in market based interest rate reform, exchange rate reform, as well as the convertibility of capital account. Dr. Wang participated in the formulation of rules and development of trading tools for the Chinese currency and gold markets. Dr. Wang’s work supports the opening up of the Chinese financial market to the world,

Every five years the SDR basket is reconsidered, the previous reconsideration was in 2010. The IMF’s Managing Director, Christine Lagarde, will be in China from March 19 to 23, 2015, “among other things, she’ll be meeting with the authorities and participating in the China Development Forum.” Will she talk about the acceptance of the renminbi into the SDR basket? Yes. From the Press Briefing by Gerry Rice, Director, IMF Communications Department, March 12, 2015:

QUESTIONER: Gerry, on her [Lagarde] trip to China, will the Managing Director be having any discussions regarding potentially including the renminbi to the SDR basket? There were some statements out of Beijing today by a senior Chinese official saying that they are having those discussions and they seemed optimistic. Is that on her agenda?

RICE: Yeah, I’m not sure what the actual discussions will be but maybe it will help if I just sort of set the issue a bit in context, the issue that you’re raising.

Again, just stepping back, the IMF’s Board reviews the SDR valuation every five years unless an earlier review is warranted by global financial or economic development. So it’s essentially every five years. So the last review took place in late 2010. And the next one is scheduled then for later this year in the latter part of 2015.

And then, the updated SDR basket would become effective January 1, 2016. So that’s kind of the review schedule, okay?

Then the criteria for inclusion of a currency in the SDR basket, the selection of currencies for the SDR basket are based on two criteria and these were set out some time ago. They are namely the size of a country’s exports and whether its currency is freely usable. So at the time of the last SDR review that was in 2010, as I said, the renminbi met the export criterion but it was assessed to not meet the freely usable criterion.

Since then, of course, there have been a number of developments regarding the RMB’s international use and so, just to circle back, the upcoming review will take stock of these developments. So that’s something that’s going to be happening toward the end of the year as I said and I’m sure there will be discussions in various fora in the run up to that date. 

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On the term from the IMF for a currency to be freely usable, in order to be allowed into the SDR basket, we must not commingle this with fully convertible. As was outlined in the paper International Reserves And Foreign Currency Liquidity, from the IMF in 2013:

A7.15 Currently the IMF does not maintain a list of convertible currencies. In 1978, the Second Amendment of the IMF’s Articles of Agreement entered into effect and the concept of “convertible currencies” was replaced by the term “freely usable currency,” 

According to Criteria for Broadening the SDR Currency Basket, an IMF paper published in 2011, “that discusses a number of reform options for the eligibility criteria for the SDR currency basket”, this does not exclude the renminbi:

The freely usable concept and its two key elements—currencies should be “widely used” and “widely traded” —are set out in the Articles and serve important operational purposes. A formal requirement for a currency to be freely usable was adopted for SDR valuation only in 2000, although considerations relating to this concept had been taken into account earlier. Indicators for assessing freely usable currencies were first discussed in 1977, and are updated to reflect subsequent developments in financial markets and data availability.

Over the last few years, China’s authorities have steadily loosened capital controls, allowing the renminbi to become the fifth most popular currency for settling global payments. With at least 60 central banks now including the renminbi among their foreign reserves. In October 2014, the UK issued the Western world’s first sovereign renminbi bond. This adds to London’s design to make the City the pre-eminent offshore trading center for the currency as the restrictions on non-domestic use are weakened. All in all, the renminbi is currently “widely used” and “widely traded”.

Furthermore, from Criteria for Broadening the SDR Currency Basket:

At their April 2011 meetings, the IMFC and the G-20 Ministers called for further work on a criteria-based path to broaden the composition of the SDR basket.

Directors have also noted that expanding the SDR basket to major emerging market currencies under appropriate conditions, and based on transparent criteria, could further expand the role of the SDR in the international monetary system.

What other major emerging market currency could they hint at next to the renminbi? Not only China has a desire for its currency to be adopted into the SDR, more G-20 members have an interest into broaden the composition of the SDR basket.

Zooming in on the characteristics of freely usable currency is interesting. From International Reserves and Foreign Currency Liquidity:

A7.18 For the recording of reserve assets, BPM6 states that “reserve assets must be denominated and settled in convertible foreign currencies, that is, currencies that are freely usable for settlement of international transactions” (BPM6, paragraph 6.72). Such currencies potentially extend beyond those currencies determined to meet the ‘freely usable currency” criterion under Article XXX (f) of the IMF’s Articles of Agreement. Countries are required to disclose at least once each year the composition of reserves by groups of currencies (item IV.(2)(a) of the Reserves Data Template). The overwhelming majority (well over 95 percent at the present time) of reserve assets reported in the Reserves Data Template are denominated in the freely usable currencies determined by the Fund under Article XXX (f) (i.e., the currencies currently included in the SDR basket).

It’s likely that if the renminbi were to be adopted into the SDR, China would have to show the composition of reserves by groups of currencies (item IV.(2)(a) of the Reserves Data Template). If we head over to the IMF webpage of the Data Template on International Reserves and Foreign Currency Liquidity, we can see many countries listed, but not China.  Additionally, from the Articles of Agreement of the International Monetary Fund:

Section 5.  Furnishing of information

(a) The Fund may require members to furnish it with such information as it deems necessary for its activities, including, as the minimum necessary for the effective discharge of the Fund’s duties, national data on the following matters:

(i) official holdings at home and abroad of (1) gold, (2) foreign exchange;

(ii) holdings at home and abroad by banking and financial agencies, other than official agencies, of (1) gold, (2) foreign exchange;

(iii) production of gold;

Currently the PBOC can hide some of its gold holdings at China’s largest sovereign wealth fund SAFE, a subsidiary of the PBOC, which “is responsible for the supervision and management of the foreign exchange market of China, to undertake supervision and management of the settlement and sale of foreign exchange and to cultivate and develop the foreign exchange market.” In short, SAFE is financial agency able to buy gold as a proxy for the PBOC. The IMF may require China to furnish information about its official gold holdings, as well as gold holdings by banks and financial agencies. If China would disclose all this information this would be a huge revelation, as China has net imported thousands of tonnes of gold in recent years that have not been officially assigned to any lawful owner. The financial industry has till thus-far assumed the gold is somewhere in China, but it’s unknown who’s holding it.

The PBOC publishes data on total FX reserves and gold, but without any specifications. These tables from the PBOC website…

PBOC FX and China Gold

can be translated into …

PBOC FX and China Gold english

These numbers are about as much as I can find on the IMF’s website about Chinese reserves (excluding TIC data).

Screen Shot 2015-03-16 at 1.45.05 PM
Reserves China, source: IMF

Total Reserves China excluding gold

It’s safe to assume PBOC gold reserves at 33.89 million ounces (1.054 tonnes) are not accurate as there is circumstantial evidence the PBOC has been buying gold in recent years through proxies.

In May 2015, there will be an informal SDR basket review, in October the basket will be revised officially.

But there is more…

OMFIF, a well-connected economic think tank, in conjunction with the World Gold Council has released a report in January 2013 titled, Gold, the renminbi and the multi-currency reserve system. One of the writers of the report was Chairman Meghnad Desai, Emeritus Professor, London School of Economics:

When it comes to international monetary reform, well before the renminbi advances to fully-fledged reserve currency status, gold might stand to reclaim a right to which it has long aspired by returning to the heart of the system. Rebuilding and reinforcing the Special Drawing Right (SDR), the IMF’s composite currency spawned in the 1960s, have been much mooted, but nothing has been done to realize this aim.

I favor extending the SDR to include the R-currencies – the renminbi, rupee, real, rand and ruble – with the addition of gold. This would be a form of indexation to add to the SDR’s attractiveness. Gold would not need to be paid out, but its dollar or renminbi or ruble equivalent would be if the SDR had a gold content. By moving counter-cyclically to the dollar, gold could improve the stabilizing properties of the SDR. Particularly if the threats to the dollar and the euro worsen, a large SDR issue improved by some gold content and the R-currencies may be urgently required.

In its absence, we may face a huge liquidity crunch if a combination of US and European shortcomings and the natural ambitions of Asia produce an attack on the major currencies – and open up a further hole in the framework of the world’s reserve currency arrangements.

As the international community attempts to take on these challenges, gold waits in the wings. For the first time in many years, gold stands well prepared to move once more towards the centre-stage. This could be the start of an immensely important phase in the history of world money. 

What do the Chinese think about this idea? Well, we’re familiar with their official policy of accumulating physical gold by the PBOC and the citizenry, more hints we can find from less official sources. According to a report from the Chinese Research Centre For International Finance, February 1, 2013:

This paper concentrates on the issue of currency convertibility in the context of Chinese strategy of the RMB internationalization. It argues that the motive for that strategy was ignited by China’s dissatisfaction with the long lasting unstable international monetary system. The recent global financial crisis intensified China’s urge to get rid of the “dollar trap” and look for a diversified international reserve currency system where the Chinese renminbi could take a place.

Looking elsewhere, there seems limited ‘high quality’ paper money in the world. The public debt in G7 countries has reached the highest level of 60 years. The traditional alerting ratio of 60% is no longer applied. Fiat money seems to have encountered a confidence crisis. The SDR, a collective form of currencies under the IMF’s account has been put under the spot light along with Stiglitz’s proposal. The proposal aimed to enlarge the SDR’s role as a supplement to the US dollar under the supervision of the IMF. However, there has been no consensus reached among the IMF member countries. Apart from paper currencies, gold has become a popular hedge instrument in the market. It has also drawn attention of its possible role to play in the reform of international monetary system.

In 2011, Chatham House set up a global Taskforce of experts to assess the possible role that gold could play, including an anchor, a hedge or safe haven, collateral or guarantee and a policy indicator.

The world is now in the transition from the US dollar hegemony to a diversified reserve currency system. China, among many other countries, is looking for dollar’s alternatives and its own currency is certainly one candidate for consideration.

One of the members of the Chatham House global Taskforce was … Meghnad Desai, who is also Chairman for OMFIF. Small world. In its research the taskforce was greatly helped by the “Chinese Academy of Social Sciences (CASS), and Professor Yu Yongding and Mr Zhang Yuyan.” Could it be there is a team of academics and policy makers around the world working behind the scenes to reform the international monetary system by adding, among other currencies, the renminbi and gold to the SDR?

The Big Reset, Part 3

KJ made it into a Dutch newspaper again! When I interviewed Willem Middelkoop last week about his new book The Big Reset, this article was picked up by Zero Hedge. Within hours the Zero Hedge guest post was viewed 40,000 times and the book jumped to second best sold on Amazon in the category finance and banking. A great succes that came up in an interview Middelkoop did later on for NRC Handelsblad, a leading Dutch newspaper.

nrc handelsblad weekend

Interview Willem Middelkoop published in NRC Handelsblad 1-2-2014

Willem Middelkoop is one of the winners of the current crisis. In 2007, the former photojournalist , entrepreneur, investor and stock market commentator wrote his first book with a sour view on the economy, If The Dollar Falls. It was followed by a book with tips on how to cope with the crisis, Survive The Credit Crisis. He sold more than 100,000 books. He became a celebrity with his gloomy comments about the financial system, but there was always a bright spot: gold. This precious metal would always continue to hold its value, as opposed to paper money.

With his latest book on a new financial system, The Big Reset, he is now making successful steps abroad. The book is already second on Amazon.com’s best-selling books about finance and banking. Again, gold plays an important role in this book. The global financial system will be radically overhauled before 2020, according to Middelkoop. The dollar will lose its place as the world reserve currency, and a portion of the sovereign debt of countries will have to be cancelled. Gold will return as a monetary anchor, and that will benefit its price, which will see new highs, according to Middelkoop.

But while he celebrates his success as a writer, at the moment he seems a lousy investor, as his predictions haven’t came out yet. The gold price has fallen steadily since its high in 2011. “I’ve been terribly wrong for one and a half years,” admits Middelkoop. Is he getting nervous ? “No, I’m more convinced than ever of the rosy outlook for gold.”

The fact that the gold price is declining fits his theory, which is that the gold market is highly manipulated, by the U.S. in particular. Excuse me? “If the price of gold gets too high, people lose faith in the U.S. dollar. That would not suit the U.S. now that it is printing $1 trillion a year and the U.S. dollar hegemony is under severe pressure.”

Middelkoop picks up a couple of charts from Australian bank Maquirie. “Look”, he says, “here is the demand for gold in China. It has exploded since the outbreak of the crisis. Oddly enough, the price has dropped. That is because of price suppression.”

It is the central message of his work: there is no such thing as a free market. The market is rigged and controlled by the U.S., with the help of its allies, with the specific intention to save the system and especially the U.S. dollar hegemony. In The Big Reset, he shows that this system is no longer sustainable.

While the economy is improving, you are warning of a collapse.

“It’s not improving. Western countries are struggling with huge debts . Government debt is quickly increasing because of the crisis. If you look at the ratio of debt relative to GDP of an advanced country, you will discover this cannot be solved. According to a recently released IMF report, it is impossible for developed countries to grow out of such debts. That rate of growth is just not attainable. It can only be performed by a very young economy such as the emerging economies. ”


“Debt restructuring is the only solution, but it will also affect the dollar. Due to the huge U.S. debt, the dollar is no longer credible as a global reserve currency. The Chinese know this. The Chinese state news agency has recently called for a new global currency to replace the dollar. In anticipation of this, they are already accumulating large amounts of gold. China even stimulates its citizens to buy gold.”

In what way is the gold market manipulated?

“Through futures contracts, which settle gold transactions at a later date. These are often used by speculators who are not interested in buying physical gold, but despite this, the price of gold is set by the trades in these contracts. By dumping large amounts of futures contracts on the market, you can bring the price down. The size of these paper markets is a hundred times larger than the physical market, which adds to the effect.”

Middelkoop is an autodidact – “I started studying the financial system in the nineties when I borrowed three million euros from a bank in order to buy real estate in Amsterdam. I wanted to know where that money was coming from” – and knows that he is sometimes depicted as a conspiracy theorist. He brings the subject up himself. “These are not conspiracy theories, these are conspiracy practices. In my book you will find a lot of evidence. Many people are starting to think in the same way. Fifteen years ago, you were an outcast when you proclaimed that the markets were not free. Not anymore. Everybody knows interest rates aren’t set by the markets. Central banks all have support operations to keep yields low.”

Middelkoop says his ideas are no longer ‘economic underground’. On the contrary, they have become mainstream. He noted that he was accosted by an eighteen year old boy at the car wash three years ago. The boy recognized him and said “Gosh, that was interesting” And then he began to tell me about the secrets of the Fed and the deceit of Monsanto.

That boy was the embodiment of a whole new generation that distrusts the economic elite and that has embraced the underground coverage, according Middelkoop . “The youth of today knows that central bankers cannot be trusted, and that you should distrust large corporations. Websites they visit are reporting a lot on these underground stories. The generation of my parents has a boundless respect for authorities. But these young people know that they are being cheated.” That boy at the car wash is now a student in political science, and even helped Willem with the research for his latest book.

The international success of his new book can be explained by the fact that people are beginning to see that his ideas and those of others are not conspiracy theories. It was an interview that appeared on the well-respected website of zerohedge.com that propelled him up the Amazon list. Zero Hedge is an alternative financial website where generous but well researched suggestions and speculations are made. The site is also read in detail by anyone who plays a role in the financial world. Within 24 hours, the interview had been viewed 40,000 times.

Who did that interview on Zero Hedge?

“There is a Dutch blogger who does research on the Chinese gold market. He publishes on ingoldwetrust.ch, under the name Koos Jansen. He did some remarkable findings and is taken very seriously abroad. I sent him my manuscript at an early stage, and he interviewed me later about my book. That interview, in English, ended up on Zero Hedge as a guest post.”

What really drives you? Why do you have an urge to show people the murky aspects of society?

“I wish I wouldn’t have to, but the deception runs too deep. One day you realize that what you learned in high school is completely false. I find it inexplicable that one would not be bewildered once they find out. That boy of eighteen was stunned and wanted to know exactly what the truth was. The same goes for me. The journalist in me wants to tell this story. I have to show this to the world, because soon no one will believe that you could have foreseen this ten years ago.”

Of course you also have an interest in turmoil in the financial markets, and in a collapse of the system. This would cause the gold price to rise, as you describe yourself, and this would suit you as a gold investor.

“I don’t like monetary turmoil but want to protect myself as an investor and as a speculator. I put my money where my mouth is. More than 75% of my assets are invested in the precious metals sector. Gold will retake its rightful place in the monetary system. Once the reset comes, the new world reserve currency will become partially backed by gold. When the Americans abandoned the gold standard in 1971, the current crisis was actually triggered. As money was no longer backed by gold, the unbridled creation of money – creating money out of nothing by central bankers – began. This created the current debt predicament. Previously central bankers were chained by gold.”

The system will return to the old ways, Middelkoop believes. “History has shown that no single currency can survive without gold.” When the rise happens, the price of gold will explode. Will he take profits? “I will only sell my gold if the price hits $ 5,000.”

Translated by KJ

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