China Gold; Asia Hold
One of the themes emerging from the Chinese press in recent weeks has been their call for the world economy to become “de-Americanised”. This was especially apposite during the debt ceiling crisis when it appeared possible that the US might default on a repayment of Treasury debt, because Congress would not extend the debt ceiling. The knock-on effects throughout the derivative and financial markets might have been as cataclysmic for the global economy as was the failure of Lehmans five years ago.
It is the primacy of the dollar, acting as the world’s reserve currency, which gives the US such huge influence over the world economy, and the Chinese have been steadily seeking to reduce this hegemony. They have reached agreements with Russia, Brazil and Australia, their key sources of commodity imports to transact in Renminbi, rather than US dollars, the usual currency of account for commodities. In addition, they have been working closely with the UK to establish London as the major financial centre for offshore renminbi transactions, with the long term objective of making the Renminbi a key currency in global markets.
It is not in China’s interests however, to destabilise the US dollar. In 2000, China owned about $600,000,000,000 (six hundred billion dollars) of US government debt, which was then about 2% of the debt owned by the general public). By July this year, that had increased to $1,300,000,000,000 (one thousand three hundred billion dollars), about 11% of the publicly owned debt, and another $700,000,000,000 (seven hundred billion dollars) in US mortgage agency debt. This has made the Chinese quite critical of the US on occasions, with regard to the inflationary impact of the QE policies pursued by the Fed, and recently when there was the possibility of a default on Treasury debt.
In fact, the share of US dollars in the Chinese foreign exchange reserves has been falling as they have diversified into other currencies, including gold. China’s gold reserves were disclosed at 1,054 tons in April 2009, but since then China is thought to have been producing more gold than any other country, none has been exported, and imports of gold into Shanghai and Hong Kong have been consistently strong. Gold commentators believe that China has about 3,000 tons of gold currently and may be targeting 10,000, which is in excess of the US reserves of 8,000 tons.
This month sees the Third Plenum of the Chinese Communist Party’s 18th Central Committee. Traditionally the first two Plenums for each Committee are concerned with personnel matters for the government and party leadership. Third Plenums have historically been used to announce new structural reforms for the Chinese economy and to reveal the major economic policies and direction that they would like to follow over the remaining 4 years in power.
For Xi Jinping, the Chinese President, the Plenum comes at a critical time in China’s economic development. After two decades of rapid export-led growth, the 2008 crash saw China implement a massive debt-funded infrastructure spending programme, much of which has been inefficiently used by the state-owned enterprises. Western demand for its exports remains muted, and the only long term solution to maintaining rapid Chinese growth is through Chinese domestic consumption.
However, Chinese consumers are huge savers, since there is no pension system and falling ill in China is a very expensive matter – the development of a welfare system is important in encouraging Chinese consumers to spend more and save less. Further, there are few legitimate outlets for their savings – interest rates on bank deposits are below inflation and the stock markets have been poor performers standing well below the peak levels seen in 1993 and 2007. Property has become the favoured investment class, which has resulted in an enormous house price boom across the whole country, even in the cities where nobody currently lives. Alongside economic reforms, the Plenum will be closely watched for any proposed political reforms, though experience suggests these will be very limited.
We expect the Third Plenum in November to continue to emphasise that China’s growth will increasingly come from its domestic consumers, so that companies will be expected to continue increasing wages and some small steps towards a larger welfare state. Financial market reform, aimed at extending the reach of the Renminbi is also expected. Such moves will give consumers the confidence and ability to boost their spending and support the development of the Chinese economy and the surrounding Asian economies. Growth in Asia should be stronger than in any other region of the global economy and led by businesses meeting the needs of the Asian consumer rather than merely seeking export markets. This was the phase of Western economic development that had the greatest impact on asset prices and supports our long term optimism for Asian financial markets and the significant role they play in our portfolios.