China’s new aspirations have the power to radically change not only the relationship between the US and China, but also between America and rest of the world.
The fact that the dollar is the nominal world reserve currency today is really quite a pretty advantage for the US.
On a recent trip to South Africa they didn’t talk about how many rand an ounce of gold was selling for, they were talking dollars; same for oil. And it goes beyond pricing.
If we need more oil and we don’t have currency to spare, that’s okay. We just print our own money, use it to buy the oil, and the Saudis take it because the dollar’s the reserve currency.
But on the day that the dollar becomes a less useful reserve currency, we have a problem.
For example, we could approach the Saudis and say, ‘we need a tanker full of oil’, and they could say, ‘Well, okay, you can pay us in Chinese yuan.’ But we don’t have any Chinese yuan, so they say, ‘Then we don’t have any oil for you.’
That’s not a problem that the US has dealt with in modern history.
It is, however, a problem other countries deal with now. When Mexico needs to import natural gas and the seller says, ‘that’ll be so many dollars,’ if Mexico says, ‘Oh, we’re all out of foreign exchange,’ they can’t import the gas. It’s that simple, they can’t print US dollars so they’re out of luck.
So anyhow, having your currency be the world’s reserve currency is an enviable position. That’s especially so, when it comes to raw materials like energy, minerals, food, and paying for whatever you import.
The Chinese likely think we have abused the position. Like I said, think like China. We’ve abused the position of our strong dollar to dominate the world, to dominate world trade, to dominate world politics.
They’d like to see the US come down off the hill, and the same thing with the Europeans. But they’re cautious and patient.
China’s Slow Currency Play
So if you’re China right now, you’re trying to break the stranglehold the dollar has over your economy, but you’re sanguine enough to understand that at this point you’re not going to knock the US completely off its pedestal.
And remember, the Chinese don’t want to be No. 1 now, because if you’re No. 1, what’s everybody else in the world trying to do? They’re trying to knock you off. They’re trying to knock you down.
So if you’re China, why do you want to put yourself in that position? No, if you’re China you simply want to compete. Although it sounds strange for a Communist country, domination can wait.
In the short-term then, what I would see happening after 2015 is China using their Treasury holdings (and their gold hoard) as leverage to turn the SDR basket more favourable to China’s economic interest.
Maybe China gets a seat at the table and the yuan is added to the SDR basket? Maybe there’s a component of gold in the basket? Either outcome benefits China’s position. On top of that we could see China try to convert its US Treasury holdings into more of the freshly-balanced SDRs.
Indeed, the Chinese would be stupid not to understand that every year of inflation reduces the overall purchasing power of the $1.2 trillion they hold in US Bonds.
Yeah, it’s a great big monetary shell game. We have these SDRs, and China walks to the table and says, ‘Okay, we have these American Treasuries, so we’re going to post our Treasuries against the IMF, and we will take an equivalent SDR in return.’
And getting back to what I said earlier, it’s very likely that the SDRs are going to have a gold-backed component; whereas right now US Treasury bonds have zero gold-backed component.
And if I’m China, some gold is better than no gold. I’d rather have 100 percent gold-backed currency, but if I can’t get currency backed at 100 percent I’ll take 50 percent, I’ll take 20 percent. I’ll take whatever’s better than zero, which is where China’s current holdings of US Treasuries stand.
This is a dynamic situation, but that’s what I think is going on. And that’s what I think we can look forward to over the next two years – a sea-change in the global monetary system.
The Takeaway
So that’s my big, huge, arm-waving macroeconomic argument for why the next couple of years are going to be very, very good for gold investors and why 2015 is going be spectacularly good for gold investors.
Up until now there has been a slow, more or less steady rise in the price of gold – you know, $1,000, $1,200, $1,500 – and the next couple of years could bring prices of $2,000, $2,500, $3,000 an ounce.
But by 2015 when the SDR revision kicks in and everybody realizes what’s going on, I think we could see gold rally substantially from its current price to north of $2,500. On the high end we could see an order of magnitude change in the price of gold from $2,500 to say $25,000 an ounce!
Right now only few sort of far-out thinkers are talking about this. Hopefully you’re one of them.
Byron King
Contributing Editor, Money Morning
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