China is ramping up gold like as if everybody in China will only consume gold from tomorrow! Its crazy but this did not strike me for a long time until we had a one hour discussion in the class today (I have to give credit to my Professor who had influenced me to write this post) that finally led to a conclusion that there is a likely possibility that China could gold standard its currency and already there are talks in the government circles. What this means is that the so called "Gold standard" currency - US dollar - will be replaced by Yuan as the global reference currency and much of the trade will happen in Yuan. Already China has surpassed USA in terms of the volume and value of trade and it has started discussions with the Middle East, Russia, and Australia about using Yuan as the medium of currency for trade. In addition, Gold is being sold in Yuan (no longer in dollar per Oz) and it is not very far that Petrol will also be sold in Yuan for by 2017, China is likely to be the world's largest consumer of Oil. If Yuan is backed up by gold, then it will be easy for China to just dump the trillions dollars of T-bills (i guess about $ 1.32 trillion). TRILLION DOLLARS OF T-BILLS!!!! Just imagine what would happen to US currency. China knows that US will not pay back that debt and neither they can for it will raise a huge cry in the US political circles. Till date, they could not dump dollar for Yuan is pegged to dollar and if it gets an alternate currency (a more stable one such as Gold - If you track gold: the spot rate of gold has remained stable for a long long time, its only because of rollovers, we have seen negative yields in gold), it is high time they would want to dump the T-bill paper. If dumped, there will be mad rush in the bond market creating prices to drop and yields to go up and as a result "Margin Calls" from other countries including Europe and Canada. Then as Prof Barrows mentioned, US will have to sell Manhattan or the entire Wall street to get its currency back on to track!
On the other hand, people around the world (including Bernanke and other central bank heads) thought that the gold prices were declining (dropped from $1800 end of September 2012 to about $1315 as on date) because of improved performance in the US and Europe. The answer to this is a partial YES but a big exclamation because who is buying all that gold that is being sold in want of US dollar (for dollar started appreciating in the recent past) - CHINA. India is a big player in the Gold market (second big player) but the form of gold that India buys is majorly in Jewelry not gold bars as is done in China. Furthermore now with the duty levied on gold imports, the imports have relatively cooled.
Lets start with Europe - Europe has a long way to go before it can even showcase the world that it is improving. Yes, the European economy as a whole improved by about 0.7% however it was mainly due to Germany, and France. German elections (due next Monday) are considered to be a critical point for a turnaround in the European growth story however it is very clear that Angela Merkel will come to power as the Chancellor of Germany but it needs to see if it will be a grand coalition with the Socialist opposition, which is highly likely to be. In which case, she will have relatively less vigor to showcase her sympathy for the failing states. There is a new party that is contesting this year that is fighting for Germany to be out of Euro! Already the sentiments in Germany is showing up in the form of aversion towards the Greeks, who are seeking another bailout package. So I am not sure if the German elections are going to make a big impact however it will in the announcements to be made by European Central Bank. The banks in the European economy are yet to build up their balance sheet to meet the Basel III regulatory requirements (minimum capital requirements) and as a result, credit market is weak (banks don't want to lend anymore and shrink their equity capital base) and thus resulting in low growth in consumer spending. The big banks are planning to raise capital from the equity market however the consumer confidence in these big banks is so low that it will be hard to expect any surprises further supported by relatively poor ROE reported by these banks. In addition, the bond market in Europe has done so well in this year (more than 14% increase in this year relative to 2011 - Thanks to the relatively low lending by the commercial banks. Europe is a market where bank financing was a major part of the borrowings for a long time) that I am not sure if the investors have the appetite. There was a chance a few months ago when the equity market were trading at relatively low P/E compared to historical average (even now it is the case) but now I am not sure. Finally the unemployment rate of about 12% is a huge issue in the region. Although the unemployment rate is showing signs of improvement but most of the jobs that are being created are for the new job seekers. Employment rate for people who have been out of jobs for more than a year has hardly shown any positivism (this is a concern even in the US). So the European growth story can barely be a factor.
US on the other hand for quite some time has been contending that it is going to taper off the monetary easing that it has been carrying out for the last five years. This speculation has caused havoc in the emerging markets except China (Yuan was the only currency that was performing well even when the US dollar depreciated). Yes, China experienced relatively low growth rate but I am again taken back to Prof Barrows class where he mentioned that as the base increases, it is relatively hard to grow at double digits. China's GDP as of 2012 is about $8.6 trillion and still expecting to grow at 7.5% per year. Actually speaking, US is the only country that has recovered very quickly from the Lehman crisis (i wrote about this in my previous blog so I am not going to reiterate) however there are certain factors that are still pinching the economy. One that, US probably no longer holds the same say in the G-20 as it used to once. The recently held G-20 (in Russia) is a classic example of this where only 50% of the nations voted for President Obama when he proposed a air strike on Syria and even out of those 10 countries that voted, only France agreed to ally with the US. Even within the home, people are not really happy with the governance for unemployment rate is still a concern. Although the government statistics show that the unemployment rate has been declining, much of the new jobs are either part time or contract jobs and even those full time jobs that are being created, they are being taken up by fresh graduates or new job seekers. Furthermore there is quite a percentage of people who have been dropping from job seeking list relative. So the 7.3% unemployment rate may not be a representative of normal rate of unemployment in the economy. The business environment seemed to be somewhat going with President's voice and now even that is going to be deterred with the "Affordable Care Act" or popularly called the "Obama Care". "Obama Care" requires all citizens of US to be insured either by a private insurance or by government insurance schemes (It is a complicated process so I am not going to dwell in to the process in this post). In addition, it also mandates employers with more than 50 employees to offer insurance to its employees or pay a fine. However it includes another clause that the employees should be full time working with the employer. This means employers particularly the retail chains and the fast food chains are going to cut down the number of hours their employees need to work and employ them as part time. In the case where there is no choice but for the employer to pay for the insurance, it will reflect in reduced salaries for the employees. So I am a bit critical if these new regulations are going to benefit the people and if it is going to improve the unemployment rate any further. In fact it might result in slow growth in employment and reduced wages and salaries. In addition, Obama Care is going to cost the government tonnes of dollars. Finally productivity is yet to return to pre-crisis levels adding to further concern. So although there might have been hints of US recovery playing a role however not as major as China buying all the Gold.
So coming back to the point, the emerging economies have become equally vulnerable to the recent recession. The world has seen two recessions following two bubbles in the last 15 years and developed markets have played a big role in both of them and as a result the developed markets were badly hit although the emerging markets survived partially. So for a while it also made the emerging markets such as India and China feel that they were "de-coupled" however they did not realize that they have actually become even more serious part of the global trade than they were before. This to some extent makes up the story that the reliance on US dollar being the global currency is slowly declining not just within the allies of US but also across the globe with over reliance on trade with emerging markets and China is trying to cash on it.
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