The secret behind Chinas gold fix: Doing away with a U.S. dollar-centric system

Chinas groundbreaking launch of a yuan-denominated gold-pricing fix on its Shanghai Gold Exchange has been downplayed by some Western analysts, who cant seem to envision a day when London and New Yorks dominance of the industry might yield to Asia.

CPM Groups Jeff Christian, for example, told one news service that the yuan-linked gold fix is old news and that it is easy for commentators to read too much into it.

And while Societe Generales Robin Bhar conceded that it was an important development, he argued that as long as it exists inside a closed monetary system, it will have limited global repercussions. For a truly efficient benchmark, the market has to be as unimpeded and unfettered as possible.

But the closer we get to the source the Chinese themselves and the fixing participants, some of whom are Western the more significance this new innovation in the gold market assumes.

Turning the tables on London: Its a market of 1.2 billion people and simply cannot be neglected, said Marwan Shakarchi of the Swiss refiner MKS, one of the 18 institutions participating in the fix. I am convinced that in the future we wont say China is at a premium or discount to London, but vice versa.

Having more sway in the gold market befits the long-term strategy of expanding the yuans role as a global currency, saidJiang Shu of Shandong Gold Financial Holdings, an arm of the Shandong mining giant and another participant.

It reflects the next stage of the internationalisation of Chinas gold market, Aram Shishmanian of the World Gold Council told The South China Morning Post.

And perhaps the most bombshell analysis of the new yuan-based fixing comes from a strategist at Hong Kong banking behemoth Bocom International. In a Bloomberg interview (edited here slightly for clarity), Hao Hong makes it clear that dumping the U.S. dollar is front and center in Chinas long-term geopolitical and economic strategy not an overnight revolution but a slow, methodical plan with many interlocking parts, of which the Shanghai yuan gold fix is just one.

Slowly chipping away at the dollar: Its a planned move to move away from a U.S. dollar-centric monetary system, he said. What were seeing here right now is actually a move spanning across more than two years. If you still remember, in 2014 Shanghai opened the Shanghai International Gold Exchange, and it very soon became the largest gold exchange in the world. And they actually trade physical gold instead of paper gold. And also I think in 2016 this year, early this year, they already announced theyre going to fix the gold price in renminbi. In so doing, were slowly chipping away at the dominance of the U.S. dollar, and for China its moving away from a U.S. dollar-centric system.

Controlling the gold-pricing mechanisms is a key part of the plan, which also has involved stockpiling valuable, strategically important commodities. Silver and gold and also petrol are three very important commodities that are priced in U.S. dollars, and I think gold in particular is one of the commodities that the Chinese central bank is hoarding very hard, Hao said. The gold reserve holdings in the Chinese central-bank balance sheet have almost doubled since 2009, so by holding gold and by doing away with a U.S. dollar-centric system, we actually require less U.S. dollar holdings.

Although SocGens Bhar argued that the yuan gold fix will have limited repercussions because of Chinas relatively closed markets, Hao here reminds us that Chinas ultimate goal is going international. He cites the Chinese yuans recent green light from the International Monetary Fund to be added into the global reserve-currency basket known as Special Drawing Rights, or SDRs. Were trying to get a seat on the international table, and obviously weve been permitted into the SDR league. Very soon this year we are going to formally be included in the SDR currency, and also in so doing were doing all these concerted moves to move away from the U.S. dollar dominance.

A new system is needed: Hao concedes that China cant dump the dollar immediately, acknowledging that Beijing holds massive amounts of U.S. greenback currency reserves. China cant immediately challenge effectively the U.S. dollar dominance, he admitted.

Still, the current dollar hegemony is no longer serving Chinas long-term interests, and therefore its time for a change, Hao said. The system used to work very well for both countries. The U.S. people buy the Chinese exports, and then the Chinese buy the U.S. Treasuries. It worked very well. It depressed the U.S. bond yield and also created liquidity in the Chinese system. But then since 2015, the whole system sort of stuck in reverse. Since 2015, weve seen a decline in Chinese forex reserves and also weve seen a very slow buildup in Chinese forex reserves and a slowdown in Chinese exports as well. So we have to work out a different system to provide liquidity, a new system to provide liquidity in the Chinese macro-economy.

Investors who dismiss the significance of the yuan-linked gold fix do so to their own potential detriment. Were talking about the worlds biggest consumer and producer of gold, and the signs are clear that China is no longer content to take a back seat to Western powers. We have trained our eyes on the global market, said Li Guohong, general manager of the Shandong Gold Group. U.S. dollar holders should be paying close attention and acting accordingly, and that means hedging for the possible day that King Dollar might have to bow before the Royal Renminbi.