Sound economic policies outweigh big gold reserves
November 2, 2012, Friday
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Print Edition
Print Edition
EDITOR'S note:
Does China have sufficient gold reserves? Campbell Harvey, a professor at Duke University's Fuqua School of Business, and Claude Erb, an investment professional, have done research that sheds lights on this questions. They provided analysis for Shanghai Daily in the following Q and A interview.
Q: Why does China hold so little gold compared to countries like the US and Germany?
A: China's historically low level of gold reserves made sense for an emerging market that had trust in the way that its trading partners managed their economic affairs.
But given the economic troubles in America and Europe, China has every reason to question its trust in the value of the dollar and the euro.
Q: China's gold storage is about one-eighth of the US. Do you think China's gold holding is enough for its economy?
A: Yes, China's central bank holds about 1,100 metric tons of gold. (Ed: the World Gold Council's number for China is 1,054.1 tons.) A popular gold investment fund holds 1,200 metric tons.
As long as China follows prudent economic policies then it has enough gold for the orderly operation of its economy. In fact, a healthy economy that follows prudent economic policies may not even need any gold reserves.
Q: What is the impact of gold holdings on a country's economy? Is a higher amount better?
A: It is hard to find any connection between the size of a country's gold reserves and the health of that country's economy. What matters for the health of an economy is that a country follows prudent economic policies. For some, a gold standard is a sound economic policy.
Q: China holds a lot of dollars and euros. Is that imprudent considering the economic risks in the US and Europe?
A: China has at least three choices to consider: 1) continue to accumulate reserves in the currencies of trading partners that it is increasingly concerned about, 2) convert some of its reserves into holdings of gold or other real assets, or 3) start conducting trade in yuan.
Is there reason to believe that the value of the dollar and the Euro will decline in the future? Yes. It is simply common sense to be prepared for unpleasant outcomes.
Is it a foregone conclusion that the value of the dollar and the Euro will plunge to zero? No. The search for economic security requires greater diversification of the tools of economic trade.
What would happen to the price of gold if China reallocated some of its existing foreign reserves to gold?
The greater the Chinese reserve allocation to gold the higher the price of gold will soar.
This is because all the gold in the world is already owned by someone.
Large scale Chinese purchases of gold will primarily benefit gold owners outside of China.
In the past the German mark was viewed as a sound currency because German monetary policy was essentially the same thing as a gold standard. It was viewed as a sound currency because the Germans followed sound economic policies.
These policies favored economic growth through exports, low inflation and a culture that encouraged both citizens and the government, on average, to live within their means.
Buying gold might be a psychologically rewarding way for China to reduce its exposure to the dollar and the Euro.
However, moving into gold, and away from the dollar and the Euro, is likely to be very expensive.
Though there may be many reasons against pursuing the Chinese equivalent of the German mark, a Chinese "gold standard" would probably benefit China more than the purchase of gold. A Chinese "gold standard" would be like the German mark "gold standard". Not an actual currency convertible into gold but a currency in which the growth of the money supply is perceived to be low.
What does this mean for China?
Gold might be a barometer of failed economic policies. Investing in barometers is not the answer; responsible economic policies are the answer.
Q: You mentioned "prudent economic policies" several times. Can you be more specific?
A: Here are a few specific policies:
1. Moderate amount of debt taken on by government, businesses, and households;
2. Balanced government spending (no persistent deficits);
3. Running a moderate trade surplus.
Shanghai Daily condensed the article. The authors' recent paper, "The Golden Dilemma" is available for free download at http://ssrn.com/abstract=2078535
Does China have sufficient gold reserves? Campbell Harvey, a professor at Duke University's Fuqua School of Business, and Claude Erb, an investment professional, have done research that sheds lights on this questions. They provided analysis for Shanghai Daily in the following Q and A interview.
Q: Why does China hold so little gold compared to countries like the US and Germany?
A: China's historically low level of gold reserves made sense for an emerging market that had trust in the way that its trading partners managed their economic affairs.
But given the economic troubles in America and Europe, China has every reason to question its trust in the value of the dollar and the euro.
Q: China's gold storage is about one-eighth of the US. Do you think China's gold holding is enough for its economy?
A: Yes, China's central bank holds about 1,100 metric tons of gold. (Ed: the World Gold Council's number for China is 1,054.1 tons.) A popular gold investment fund holds 1,200 metric tons.
As long as China follows prudent economic policies then it has enough gold for the orderly operation of its economy. In fact, a healthy economy that follows prudent economic policies may not even need any gold reserves.
Q: What is the impact of gold holdings on a country's economy? Is a higher amount better?
A: It is hard to find any connection between the size of a country's gold reserves and the health of that country's economy. What matters for the health of an economy is that a country follows prudent economic policies. For some, a gold standard is a sound economic policy.
Q: China holds a lot of dollars and euros. Is that imprudent considering the economic risks in the US and Europe?
A: China has at least three choices to consider: 1) continue to accumulate reserves in the currencies of trading partners that it is increasingly concerned about, 2) convert some of its reserves into holdings of gold or other real assets, or 3) start conducting trade in yuan.
Is there reason to believe that the value of the dollar and the Euro will decline in the future? Yes. It is simply common sense to be prepared for unpleasant outcomes.
Is it a foregone conclusion that the value of the dollar and the Euro will plunge to zero? No. The search for economic security requires greater diversification of the tools of economic trade.
What would happen to the price of gold if China reallocated some of its existing foreign reserves to gold?
The greater the Chinese reserve allocation to gold the higher the price of gold will soar.
This is because all the gold in the world is already owned by someone.
Large scale Chinese purchases of gold will primarily benefit gold owners outside of China.
In the past the German mark was viewed as a sound currency because German monetary policy was essentially the same thing as a gold standard. It was viewed as a sound currency because the Germans followed sound economic policies.
These policies favored economic growth through exports, low inflation and a culture that encouraged both citizens and the government, on average, to live within their means.
Buying gold might be a psychologically rewarding way for China to reduce its exposure to the dollar and the Euro.
However, moving into gold, and away from the dollar and the Euro, is likely to be very expensive.
Though there may be many reasons against pursuing the Chinese equivalent of the German mark, a Chinese "gold standard" would probably benefit China more than the purchase of gold. A Chinese "gold standard" would be like the German mark "gold standard". Not an actual currency convertible into gold but a currency in which the growth of the money supply is perceived to be low.
What does this mean for China?
Gold might be a barometer of failed economic policies. Investing in barometers is not the answer; responsible economic policies are the answer.
Q: You mentioned "prudent economic policies" several times. Can you be more specific?
A: Here are a few specific policies:
1. Moderate amount of debt taken on by government, businesses, and households;
2. Balanced government spending (no persistent deficits);
3. Running a moderate trade surplus.
Shanghai Daily condensed the article. The authors' recent paper, "The Golden Dilemma" is available for free download at http://ssrn.com/abstract=2078535
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