So Long, Dollar…Hello, Yuan

In a 2015 Vanity Fair article Nobel Laureate Joseph Stieglitz broke the bad news: China was well on its way to overtaking the United States as the world’s largest economy. By the time Stieglitz knocked out his piece, the Chinese nation was indeed entering 2015 in the top spot.

But if you measure by exports and household savings, China outpaced the United States long ago. Chinese savings and investment were almost fifty percent of GDP; and, according to Stieglitz, the Chinese were as worried about their citizens’ saving too much as we are about ours saving too little. In manufacturing, China was clearly ahead; while in terms of the number of patents awarded, though we were ahead, China was close on our heels.

Stieglitz offered some fascinating historical context with a comparison between Britain and the United Sates in the nineteenth century:

“Tectonic shifts in global economic power have obviously occurred before, and as a result we know something about what happens when they do. Two hundred years ago, in the aftermath of the Napoleonic Wars, Great Britain emerged as the world’s dominant power. Its empire spanned a quarter of the globe. Its currency, the pound sterling, became the global reserve currency—as sound as gold itself….Britain’s dominance was to last a hundred years and continued even after the U.S. surpassed Britain economically, in the 1870s. There’s always a lag (as there will be with the U.S. and China).”

What’s particularly noteworthy is how the pound sterling became the standard global reserve currency, just as the U.S. dollar is currently the dominant global reserve currency.

Fast-forward to 2016: China’s now aiming for another monetary game-changer: for their yuan to replace the dollar on the international gold market. As Meera Shawn wrote in April on Market Realist, their new daily gold fix, denominated in yuan, and in direct competition with London’s LBMA gold price, is giving other markets a literal run for their money.

Perhaps not unfairly, the Chinese believe since they’re the world’s largest consumers of gold, they should have greater influence on the international gold market. In her April 27 article, Shawn warns, “With the larger influence of gold in the financial system, China may get in a position to dominate global economies.” We shouldn’t discount this as a possibility.  The IMF has recently included the yuan in its Special Drawing Rights (SDR) basket of currencies, alongside the U.S. dollar, the Japanese yen, the euro and the British pound. Shawn, along with others, has also suggested that China plans to park money in gold and diversify away from its U.S. dollar assets.

Of course, this begs the question: Do we just passively monitor these developments, or do we consider learning some strategy from—let’s face it—our economic adversaries?  Like it or not, it’s a smart play to diversify at least some of our dollars, and dollar-denominated assets like stocks and bonds, into physical gold.  While any number of financial shenanigans the Chinese might get up to could easily disrupt the markets our portfolios depend on, including, terrifyingly enough, our retirement accounts, they’re not going to mess with gold.  They need gold’s enduring value to succeed in the long term, and it turns out we could all benefit by taking a page from the other team’s playbook.