“If China really wants to decouple from the US (and US consumer demand), it really needs to support the consumption of its own households…”
Luke Gromen's take on China, Bonds, Currencies, Gold and more... Article #82
I am sharing Luke Gromen’s 9th “Tree Ring” from his FFTT Tree Rings Report on August 23, 2024, in this bi-weekly Wednesday guest post.
“If China really wants to decouple from the US (and US consumer demand), it really needs to support the consumption of its own households…”
Tree Ring: The Council on Foreign Relations’ Brad Setser (one of the world’s foremost experts on Balance of Payments analyses) asks what has been and remains a/the key question regarding China de-coupling from the US…
…supported with the key macro data to frame the question and discussion.
Setser’s chart shows that global trade for the past 25 years can be summarized in a nutshell thus:
China and OPEC+ send goods to the US, the US sends USDs to China and OPEC+, who then recycle those USDs into USD-denominated assets.
This is why the US Net International Investment Position (NIIP) has gone from -10% of US GDP to -80% of US GDP over the past 25 years: The US has essentially hocked its family silver to finance consumption from China and OPEC+…but now, China and the US are trying to decouple from each other.
This means the US needs both a lot more production (inflationary) AND a lot more buyers for USTs (ultimately the Fed and/or its proxies, very inflationary), while China needs to find enough domestic buyers for its own production (deflationary.)
Given that China and the US decoupling from each other would be secularly inflationary for the US and secularly deflationary for China, one would expect to see Chinese 10y government bond yields to fall relative to 10y UST yields as this decoupling progresses…
…which is exactly what has begun happening:
How can China improve domestic demand to rebalance its economy? If it was up to us, we would recommend China give Chinese citizens its tacit blessing to buy gold by opening up its gold markets for the first time in 50 years, which occurred in 2002…
Shanghai opens gold exchange for trading – 10/31/02
“The official opening of the gold exchange Wednesday ended the 50-plus years of government monopoly over the gold market. Since the founding of the People’s Republic of China in 1949, Chinese gold producers had sold all of their products to the central bank, which had then allocated the precious metal to gold processors.”
…and then we would explicitly encourage their citizens to buy gold as a wealth reserve asset, which the CCP began doing in 2010 (if not earlier)…
The Chinese government is urging its citizens to buy gold – 7/8/10
“The country is also turning to television advertising to encourage its growing middle class to buy gold as an investment. State-owned China Central Television has run spots urging citizens to buy gold, as well as silver, a major shift from only a few years ago when the country imposed strict controls on precious metals purchases for its citizens.
China has also been ramping up its gold reserves and hopes to increase future holdings through unique agreements such as the one signed recently with Coeur d’Alene Mines Corp. to buy gold concentrates from a mine in Alaska. It’s the first deal of its kind between China and a U.S. miner.”
…and then we would let the CNY price of gold rise, inexorably, and on relatively low volatility, quietly building wealth for an eventual Chinese consumer class…which per the chart at right, has been happening since 2002:
When oil & commodities were only priced in USD, gold rising in CNY as seen at right would be a sign of CNY falling sharply against the USD, and therefore be signaling a 1997 SE Asia-like currency crisis coming in China.
But this is why CNY oil and commodity pricing was so critical for China to establish over the past decade. Now gold rising in CNY terms the way it has been is merely a sign that gold buys more oil in China than in the west, which will drain gold from western vaults inexorably, unless USD gold prices follow CNY gold prices higher.
Russia has long been supporting this (by accepting CNY and buying gold), while increasing Swiss gold exports to Gulf Countries suggests that the “oil net settled in gold” trade (and therefore higher gold prices) is picking up pace (below, red.)
More “oil” demand for gold will further enforce this systemic transition, since oil markets are ~12-15x the size of global gold markets in annual physical production terms, which means oil will likely continue to bid up gold (likely why the gold/oil ratio keeps rising), increasing Chinese consumer net worth over time, via gold prices…
…which Chinese consumers will eventually use to buy more oil and other consumer goods…wash, rinse, repeat in a virtuous economic cycle.
The more gold goes up, the more Chinese gold net worth rises to offset losses in Chinese real estate. The more gold rises v. Chinese real estate, the more Chinese will see gold as a store of value rather than real estate. The more that happens, the more affordable real estate will become in gold terms for Chinese, which over time should lead to a reduction in the number of Chinese buying multiple apartments to hedge currency risk.
This will then lead to more supplies of affordable housing for younger Chinese people, which should improve domestic political stability in China, while also increasing the domestic consumer class (more gold at higher prices = more ability to buy Chinese goods.)
In our view, this is what China is doing: Paradoxically, communist China has been encouraging its people to buy gold (which represents decentralized economic sovereignty) for over two decades, in order to build a politically-stable, more self-sufficient domestic consumer class.
We say “paradoxically” because “capitalist” US has been encouraging its people to sell gold and buy US government debt as its savings, so that the government can more easily steal its people’s real purchasing power via inflation, to support US government deficits, at the cost of making the US more politically unstable (as US cost of living rises and standards of living fall inexorably), while also making its citizens LESS self-sufficient and MORE dependent on the US Federal government.
Will China be successful in making this transition? We do not know…but the evidence continues to build that China’s momentum in this endeavor is building (see any number of “China” stories in the past four weeks’ Tree Rings, for example.) What we have the highest conviction in is twofold:
What we describe here bodes VERY well for gold prices and the gold/oil ratio, over time; and ultimately, if the US wants to compete, it needs to both rebuild/reshore our domestic production base, AND finance US deficits at significantly negative real rates…which will likely be very good for gold and BTC prices (as well as US equity prices, inflation, and nominal US GDP growth…but bad for the USD, and LT USTs on a real basis.) Let’s watch.