Why the West sells gold and China buys it.

A number of readers and bloggers have recently suggested there must be collusion between America and China over the transfer of physical gold from Western capital markets. They assume that governments know what they are doing, so there is a bigger game afoot of which we are unaware.

The truth is that China and Western capital markets view gold very differently. You will hardly find anyone in the London Bullion Market who regards gold as money; and for them if gold is no longer money Chinese demand for it is not a monetary issue. Instead it threatens the bullion banks’ business that a useful financial asset, capable of earning many times its physical value in fees, commissions, turns and interest, is being leeched out of the market by Chinese aunties.

It is clear that nearly all Western central bankers share this view, believing that gold will never play a monetary role again. We also know that Marxist-educated government advisers in China have been sheltered from the Keynesians’ antipathy against gold and instead have been brought up on Marx’s belief that Western capitalism will eventually destroy itself. It therefore follows they believe that western paper currencies will probably be destroyed as well.

Otherwise we can only speculate, but the following conclusions about why the Chinese are accumulating gold seem to make most sense:

• There is a fundamental view in China that gold is ultimately money, so it is always worth accumulating by selling potentially worthless foreign currency.

• Encouraging her citizens to accumulate gold achieves two objectives: if they have real wealth to protect it makes them potentially less rebellious in difficult times; and secondly private buying of gold reduces the trade surplus, which in turn reduces the accumulation of foreign currency reserves.

• Gold is generally accepted as superior money throughout Asia, which is China’s long-term regional interest.

• The Chinese Government (and/or the Communist Party) is buying gold for itself. Assumptions it will use gold to beef up the renminbi makes little practical sense, beyond perhaps some window-dressing for currency credibility. Instead she appears to be accumulating gold for unstated strategic reasons.

• Keeping the West short of gold gives China huge leverage in today’s cold currency war, and even more if the currency war heats up.

The idea that America is colluding with China in the gold market must therefore be nonsense. The truth has everything to do with different philosophies about gold.

Advanced western economies have survived without using gold as money for a considerable time. Currency and credit inflation have created a modern finance industry wholly dependent on fiat paper and everyone in mainstream finance is conditioned to believe in the profitable world of fiat currencies. They are therefore predisposed to dismiss gold as never being money again.

That is why the West is less worried about losing physical gold than it should be, and China is glad of the opportunity to buy it. And she can be expected to continue to do so whatever the price, because she knows that in the final analysis gold is the only true money.