2013-07-22

Gold's last stand as China's Great Depression looms

I have no idea how gold will perform in an outright recession in China, which would likely be accompanied by a currency crisis. I can see gold collapsing in price as bubble investors (gold is a bubble in China in terms of investor psychology) puke gold onto the world market. I do not expect the central government will puke gold because gold is an independent asset, politically superior to the U.S. dollar. On the flip side, if the yuan collapses it will take all the other emerging market currencies with it. The question then is whether this causes hoarding of gold or whether the epic U.S. dollar rally this will trigger will lead to a collapsing gold price.

At least initially, gold would fall because many investors are primed to think stronger U.S. dollar means weaker gold price and vice versa. This U.S. dollar strength would peak at the end of a financial crisis in China. It would be temporary and ultimately illusory as the rising greenback raised U.S. debt levels relative to the world, setting up a bigger crisis down the road.

The best policy for China in a currency collapse scenario would be to nationalize gold holdings, essentially a repeat of FDR's move in 1933 except that they wouldn't steal from the Chinese people as FDR stole from Americans. Instead, the central bank would most likely buy the gold from the public at an inflated price that would balance the books and end a run on the yuan. The Chinese economy would emerge from this depression "debt free" with a gold-backed yuan.

China risks deflation trap as true GDP crumbles
“The economic return on credit is rapidly declining. They increased loans by $1 trillion in the first quarter, but growth slid anyway and is now below levels seen in early 2009 after the Lehman crisis. It is no longer out of the question that GDP will actually fall,” he said.
Diana Choyleva, from Lombard Street, said the official Chinese figures show that the economy contracted by 0.2pc in the second quarter, rather than growing 1.7pc (7.5pc year-on-year) as claimed by the government.

The discrepancy comes from the inflation assumptions used by Beijing. The government relies on a fixed basket of prices that can flatter the true health of the economy.

A better benchmark is the “GDP deflator”, which uses an evolving measure of prices that better reflect the reality of China’s fast-changing economy. “If you measure it that way, China is much closer to deflation than people realise,” she said.

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