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China’s Gold Rush Reflects a Loss of Faith in the Growth Miracle

John Lee

If the common wisdom is correct, that China sailed through the global crisis and is less dependent on stagnant western economies for growth, why the rocketing demand for gold? It is usually seen as a defensive asset, but China’s imports of gold from Hong Kong—a proxy for overall import demand—have trebled since 2010. The World Gold Council predicts it will this year overtake India as the world’s largest gold market.

The usual assumption is that the Chinese want to shield themselves from problems in the eurozone and US. But this also suggests that many Chinese are far more worried about the sustainability of their economic miracle than outsiders realise.

Who is buying all the gold bullion? Many assume it is the People’s Bank of China. After all, with $3.18tn in foreign exchange reserves, gold is a safe alternative to hard currencies. Beijing is not transparent about how it deploys these reserves. But the PBoC has periodically admitted that it is looking to diversify away from dollars. Gold-buying mystery solved?

Not really. Though the BPoC is behind some of the recent buying, it cannot be behind most of it: there has been no huge sale of Beijing’s dollar or euro assets, which would have had to occur for it to buy that much gold in international markets. China’s foreign exchange reserves have also shrunk quarter on quarter for the first time since 1998, meaning that Beijing has less foreign cash to buy gold on international markets.

Nor can institutional Chinese investors account for the huge rise in gold imports. Figures suggest their demand for gold is met by stocks from domestic mines. Indeed, with economic growth at 9 per cent, one would not expect huge increases in their demand for gold.

This leaves private households, now able to buy gold easily through the official exchange in Shanghai, and through unofficial exchanges that have popped up in big cities over the past two years. The fact that authorities explicitly banned private households from buying gold except through the Shanghai exchange is strong confirmation that they are driving demand – and there is overwhelming anecdotal evidence.

Why are Chinese households buying a defensive asset in a time of rapid growth? One reason could be the fear of inflation, which peaked at 7 per cent in mid 2011. But gold-buying by households has increased over the past two years regardless of inflation numbers rising or falling.

A better explanation could be the lack of alternatives for households that are the best savers in the world. In an economy lacking financial sophistication and depth, options are limited to savings accounts, which offer negative real returns, stocks listed on one of the two national exchanges, or else property.

The problem with stocks is that in most listed companies, state-owned enterprises hold a majority of shares. Combined with abysmal financial reporting, poor transparency and lax trading rules, stock prices are easily manipulated by insiders.

Property is the other alternative. But Chinese knew of the country’s infamous ghost cities long before the international media. Knowing that yield was irrelevant, as many of these properties will never be rented out, locals knowingly bought them as speculative capital assets. Now prices have collapsed in many areas, locals are much more wary of pouring capital into an asset that may never offer a reliable return.

Because of formal capital controls, only the very wealthy and well-connected are able to transfer their money abroad. For the rest, buying precious metals is one way to hedge against an uncertain future. As one Chinese businessman said to me recently, “these luxury apartments could be worthless, because no one will ever live in them, but gold can be sold to someone outside China.”

As the Japanese and American experiences in the late 1980s and 2008 show, cheap or free credit is a sure way towards bad investment decisions and asset bubbles. Bank loans for fixed asset investment in China has jumped from $750bn in 2008 to $1.2tn a year—and this does not include hundreds of billions of “hot money” entering the country. Amid all the talk of a China-dominated Asian century, the country’s modern version of a gold rush is a sober reminder that locals could be losing faith in the growth miracle that appears the brightest light in a dimming global economy.

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