Risk and Reward: China's Golden Hammer

Game Theory is the study of mathematical models of conflict and cooperation between rational strategic decision makers, which is essentially a fancy way of saying “Think about something from the standpoint of your opponent, and try to figure out what their most logical move is”. So I started thinking, which is admittedly a dangerous thing, about Game Theory in relation to China’s now considerable gold hoard. What follows is merely my attempt to stimulate a conversation on one of the most significant potential economic shifts any of us are likely to see. Please be warned that I claim no special training in or understanding of international currency flows, monetary policy strategy or implementation, or pretty much anything else. But since the financial press and others within the mainstream investing world seem intent on pretending that none of this is happening, well… somebody should talk about it.

Let’s do some crude, back-of-the-napkin calculations and see where this train of thought leads:

There are 35,274 ounces in a metric ton of gold.  Let’s say that China’s actual total gold holdings are now around 5,000mt as reported in this Reuters article.  Five thousand metric tons would be about 176 million ounces.  As I type, the price of gold is roughly $1,250 per oz, meaning that China’s 176 million ounces would have a current market value in US Dollars of $220 billion dollars. Meh.  No biggie.

But what would happen if the Chinese prominently announced their gold holdings publicly? Surely such an announcement would shock the financial world, and even more so if they then publicly called into question the status of US gold reserves (unaudited since 1952, probably for good reason).  What if China made the claim that they now have the largest amount of gold reserves of any nation on earth, and dared the US to prove them wrong with a fully public audit?  What if they announced this fact while at the same time prominently noting all of the separate trade agreements they have signed in the last two years that cut out the US Dollar from trade settlement-  you know, the agreements they have signed with Russia, India, Japan, France, Australia, Brazil, and others?  It seems quite probable, in such a scenario, that gold priced in USD would reset quickly some multiples higher.

I do not think that, in the resulting turmoil that would surely be caused by this scenario, a revaluation of gold to $10,000 per oz would be an unreasonable outcome. If so, what would/could this mean?

A revaluation of gold to 10,000$ per oz would make China’s “stack” worth 1.76 trillion in USD- a gain of 1.5 trillion dollars over its present worth.  Not too shabby, but wait- there’s more.  Let’s say that this gold was then used to “back” the Chinese Renmimbi in some sort of international trade settlement system…  and really, what else are you going to do with a stack of gold that size? Let’s posit a realistic “gold backing” figure that most markets would accept- say a 20% backing.  This leverages the value of the current Chinese gold hoard to 8.8 trillion dollars. Now we are talking some serious cheddar.  

But wait, there’s more!

China has become the world's biggest trading nation in goods, ending the post-war dominance of the US, according to official figures. China's customs administration said the combined total for imports and exports in Chinese goods reached $3.87tn (£2.4tn) in 2012, edging past the $3.82tn trade in goods registed by the US commerce department… US total trade amounted to $4.93tn in 2012, according to the US Bureau of Economic Analysis (BEA) with a surplus of $195.3bn. But like most western nations, the US deficit in the trade of goods weighs heavily and is only expected to get larger. The deficit in goods was more than $700bn compared with China's 2012 trade surplus, measured in goods, which totalled $231.1bn. http://www.theguardian.com/business/2013/feb/11/china-worlds-largest-trading-nation

A scenario like this would mean that these figures would skew even more heavily to China and away from the US, thus leveraging the value of such a move even more in terms of future trade and “controlling interest” in the world economy.  Suffice it to say that, even if the estimates given in this exercise are incorrect (and they almost surely are), it is still reasonable to suppose that some combination of these, centered on this now formidable gold hoard and coupled with various other stratagems at their disposal (use of their 1.3 trillion in US Treasury bonds, for example), could be used to accomplish essentially the same thing.

The bottom line is that China holds all the cards now: they are the largest export economy in the world, have the biggest concentration of manufacturing infrastructure and expertise in the world, and they now possess an enormous gold reserve (augmented by the largest gold mining output of any nation in the world, set to exceed a whopping 400 tons this year alone).  They truly possess a Golden Hammer, and with one blow they could choose to establish themselves as the new economic Hegemon of the 21st century.  They likely have the ability to do this right now, as we speak.

So why don’t they do it? 

Aside from the obvious fact that the longer they wait the more powerful their position becomes, I suspect there are two  interrelated reasons.  One is the still formidable power of the US military (and particularly the nuclear weapons arsenal), and two is the irascible and “quick to anger” nature of the US public. The last thing China wants is for a hard crash to engulf the US economy and have a hot-tempered US public placing the blame squarely on China. Things could get out of control quickly, and this would not be in their long-term interests.  In order for China to swing their Golden Hammer, it is imperative for them to be certain that the US public will be pointing fingers at Washington, not Beijing.  They simply cannot afford to be the scapegoat for the inevitable destruction of the current US standard of living and the seething anger this will inevitably engender.

So it seems the most logical strategy for China is to 1. Quietly move pieces around the board, putting agreements, infrastructure, and resources in place to be ready to assert their position as Hegemon when the time is right, and 2. Wait patiently for a meltdown (of banks, markets, or the US economy as a whole) that will give them the cover to THEN make their big move without fear of provoking the US public and therefore risking a destructive military confrontation. 

In the meantime, they continue to flex their geopolitical muscles in various places, such as unilaterally proclaiming a huge “no-fly without our permission” zone over international waters. They continue to sign trade agreements and have second-tier functionaries make public pronouncements about the weakness of the US dollar or about no longer accumulating US dollar currency reserves. They may even quietly work to hasten the process of western fiat crisis a bit in various markets, possibly using those 1.3 trillion dollars in treasuries, once they feel more confident of their position.

Regardless, what will really get my attention will be what China does in the aftermath of the next 2008-style western financial crisis.  My suspicion is that they will wait until the self-inflicted wounds of the west finally result in a debacle the politicians and central planners cannot control or hide from the public.  In the aftermath of such a crisis, they will wait until US public attention (and blame) is squarely directed at Washington, then they will swing their Golden Hammer. 

And from that point on, the world will be a very different place.

85 Comments

Mr. Fix's picture

1

smiley

ag1969's picture

Nice one Pining

What is probably more scary to China than the USA's nuclear weapons, is the fact that the USA is the only country on earth that has demonstrated the sadistic willingness to actually use them.

2nd Amendment

A well regulated militia being necessary to the security of a free state, the right of the people to keep and bear arms shall not be infringed.

Thorus's picture

Minimal risk approach is - let us rot

Pining,

I'd suggest the maximum benefit - minimum risk approach for China is to just quietly let the US rot.

We're debasing our currency all on our own.  We're incurring enormous debt all on our own.  We're undermining anyone's efforts to work hard and get ahead by taxing them by increasing amounts as they do so - and giving the money taken from the hard workers and using it to incentivize people to sit back and let the gov't take care of them.

Rather than actually shove us off the cliff, and making themselves a potential target for a backlash of anger, they can just let us stumble along the cliff edge like drunken sailors - and when we finally fall, it's all our own fault.

The Chinese just happen to be standing nearby and are ready to move and benefit from our downfall.  Can't blame them for doing that.

In other words, pretty much what you suggested.  ;-)

Regards,

Thorus

treefrog's picture

froth

ribbit!  ribbit!  kneedeep!

Whitecastle123's picture

Like a sneaky

Crouching Dragon.  It's totally diabolical.   

Pining 4 the Fjords's picture

Of course, our rational individual counter-move for this is...

Piggy-back on China's strategy and stack it while we can! 

If only there were some easy way to do this, at cheap prices...  Hmmmmmm... 

HappyNow's picture

Interesting idea Pining and

Interesting idea Pining and it all adds up.

When the next 2008 style financial crisis arrives and the public is just hot enough then China could appear as the "sensible one" who calls out the West.  If done carefully they will ignite the fuse to the powderkeg, wait a week or two for MSM to fall in line and the Western public to blame their leaders and then say  "You can all see the mess.  The West has become so irresponsible that we must insulate ourselves by using our own gold-backed currency".

This will totally make sense to the Western public, and finish the political job.   Nobody will blame China.  After all anyone can see things are such a mess and why should they get dragged down?

Unhappily this will make a huge mess of the West's finances.   Happily I have a stack.

opticsguy's picture

It's all up to the Saudis

When OPEC and the Saudis take RMB/gold for oil, what you propose will happen.

We (Obama admin) will screw something up in the middle east and the Saudis will leave the dollar.  Then the Saudis will be responsible for both 9/11 AND crashing the US economy.  With SA as the focal point of public hatred for $10 gasoline, the Chinese make their move.

Sun Tzu:  All war is deception.

Pining 4 the Fjords's picture

A double thank-you Happy

First for the kind words, and second for your outstanding PM conversation with me earlier in the week. 

Folks, I asked HappyNow's opinion on several issues related to this article after a post he made, and he wrote back an outstanding 3-page reply that crystallized my thinking on this, and kept me from a few errors I might otherwise have committed.  This is a truly generous community, with some seriously good people!

Whitecastle123's picture

That's great pining

That pic should be on T-shirts for all Turdlets to buy. 

AlienEyes's picture

@ opticsguy

911 ? Yes!

The dollar decline? NO WAY !

The Marxist ass-hat in the A-hole office and his pet banksters should get all the credit for that.

argentus maximus's picture

The "Great Game" never ends

The "Great Game" never ends does it?

What about the area of most competition .... the natural resources of Africa?

It's likely the prime regional superpower war location for the 21st century - not so good for the people living there.

Green Lantern's picture

China chasing US and Japanese

China chasing US and Japanese air fighters in the East China Sea recently is part of this fight for global dominance.

We don't like having the ChiCom's chasing our tails.    But in the game of dollar hegemony, the administration is going to have play with China or else......

Of course, Japan welcomes the United States military on their sovereign land.   Oh that's right, they wanted the US to leave and Robert Gates went over and told those Japanese how it is. 

Green Lantern's picture

China chasing US and Japanese

China chasing US and Japanese air fighters in the East China Sea recently is part of this fight for global dominance.

We don't like having the ChiCom's chasing our tails.    But in the game of dollar hegemony, the administration is going to have play with China or else......

Of course, Japan welcomes the United States military on their sovereign land.   Oh that's right, they wanted the US to leave and Robert Gates went over and told those Japanese how it is. 

Green Lantern's picture

China chasing US and Japanese

China chasing US and Japanese air fighters in the East China Sea recently is part of this fight for global dominance.

We don't like having the ChiCom's chasing our tails.    But in the game of dollar hegemony, the administration is going to have play with China or else......

Of course, Japan welcomes the United States military on their sovereign land.   Oh that's right, they wanted the US to leave and Robert Gates went over and told those Japanese how it is. 

ancientmoney's picture

China has become the wildcard in financial system . . .

China has done in about 30 years what it took the U.S. a century to do--become the industrialized world's collossus.  Of course, they got a big push from western oligarchs, who moved their manufactories and labor from the U.S. to China and other places.

Even China did not foresee that their hoard of western currency reserves would become, on the whole, worthless.  This is proven by the fact they had almost no gold reserves prior to 2012.  They are certainly doing now what they can by spending at the margin to buy anything tangible.  But, they are stuck with several trillion$ in fiat currency that is essentially worthless--and they know it.

So, when they figured this out, they called over Timmy Turbotax Geithner in 2010 and again in 2012 for high-level meetings.  It was at those meetings that the agreement to ship western gold in exchange for a Chinese promise not to dump USTs en masse was arranged.  Since then, there has been a steady, unabated flow of western gold for points east.  Maybe there is a quota . . .

The Chinese are intending to, first, replace the value they will lose when the world realizes their currency reserves are worth nothing.  Gold is the instrument that will replace that lost value.  But as Pining points out, gold must be revalued much higher to be able to counterbalance the excess of fiat reserves they hold.

Still, they don't intend to get suckered into accepting fiat again in the future.  So, once they have their acceptable level of gold, they will require any trade deficits due them to be made in gold.  The whole world will be forced into this arrangement. 

So, if the U.S. buys $10B of trinkets from China, and ships them $8B in soybeans, we will need to come up with $2B of gold.   

It'll be easier to come up with that differential when gold is $50,000 per ounce.

That is FOFOA's number for what he thinks it needs to be.  Another thought it would be the Eurozone that did this revaluation, but they were also sucked into American fraudulence, as China entered the scene, and was taken for fools by the western oligarchs.  now, all that is changing.

kardnul's picture

A Ron Paul moment

What if China made the claim that they now have the largest amount of gold reserves of any nation on earth, and dared the US to prove them wrong with a fully public audit?

----------------------------------------------------------------------------------

What a bitchslap that would be!

Gramp's picture

Observations from the Man on the street...

Nothing stays the same.

  Hey Good write up Pining.

In doing business with Asian folks who have recently pushed their way into the seafood industry here... These folks are VERY intelligent. That is the greatest impression i get from the way they conduct their business. Cold, with little care for the individual who is harvesting the product they are so eager to procure.

  Many other harvesters don't like the new faces looking to buy product... but they are bring competition and many $'s to market.   I welcome that of course... but they have shown their cards to early and attempted to drive out other buyers with price games, with some success... then trying to push the product price VERY low, in hopes the other buyers would follow the 'trend' of price manipulation and easy money. Well guess what. The Americans who have been in the industry for decades... Held their price up, in doing so showed their integrity and re-affirmed their market share! 

judejin's picture

it's not in any elites' interests to back currency with gold.

the chinese elites are not different. they want to use fiat money.

chinese may or may not have 5000 tons of gold.

but, if you guys check the shareholders of major gold miners in the world, almost all of them are owned by western interests.  chinese shareholding in them is close to O!

goldman sachs' ex-president just became chairman of barrick gold.

vampire squids are devouring gold miners.

goldbugs and silverbugs may have all the ultimate theory/logic/reason/morals that god ever wants man to know. but this world is not run or ruled by reason!

so, we have to become adaptive. otherwise, we might perish like hunt brothers too.

don't fight with the squid. learn to ride it.

china's dependence on real estate is as sick as than japan was. so please don't put too much faith in china. 

if USA wants to fight with china, china will lose.

USA has 10 aircraft carriers, 50 nuclear submarines.

china has 1 aircraft carriers(half the size of the US carrier). 10 nuclear subs.

when USA goes into hyperinflation and self-destructs, USA can bring down china physically quitey easily.

it all depends on how the psychos that rules USA now.

hold onto your gold/silver. but bitcoin could still be far better.

this is an insane world!

unwired's picture

Golden Hammer

I was thinking along similar lines.... reminded of it again this AM with this ZH post...

http://www.zerohedge.com/news/2013-12-02/chinese-yuan-surpasses-euro-becomes-second-most-used-currency-trade-finance

China has been preparing with currency swap agreements over the past few years and it looks like those results.... getting the Yuan to be more widely accepted are working.

China... more recently has become bolder in its pronouncements.... "moving toward a de-Americanized world".... "no longer willing to grow currency reserves.... now in China's best interest to let the Yuan strengthen".

Seems like.... the next step in this process might be some announcement regarding gold reserves. I think one pro-active thing China can do is step visibly into the gold arena...right now.... and with impunity....before the next crisis in the west unfolds. I don't think China can sit by and let any western crisis overtake them. I would think they would want be more in a position of strength ahead of it (not that they aren't already).... so that as a result of the crisis.... the East looks better and more stable.

I don't see how the USA can publicly defend and justify themselves.... and portray China as damaging the west's financial position because of actions in gold. The west and its MSM shills have been attacking and putting down gold as an asset class for decades. Bernanke said its not money. They'd have no credibility in saying the gold market is suddenly the most important market on earth... and showing China's 'aggression' etc. No doubt Russia would be in China's court... and prob even Germany and the UK. And besides... the American public is too stupid to even realize what is going on.

China was severely damaged in the 30's by the USA putting a floor under silver and buying all that was offered. This created deflation and depression in China because they were on a silver standard.... with their money being exported out of the country. History shows this ultimately was a targeted effort to eventually de-monetize silver. China could actually do the same thing.... to help re-monetize gold and add credibility to China's currency and finances. Paybacks could be a bitch. Reg Howe detailed a simple plan... it makes perfect sense. And would result in China's imports of gold getting even stronger I'll bet.

http://www.goldensextant.com/ChineseGPS.html#anchor29599

Nick Elway's picture

32150 troy ounces in a tonne (metric ton)

Great post Pining, the geek in me points out 32150 troy ounces in a tonne.  The tentative game theory conclusion  is not affected by this nitpick.

Fine image of  Turd with tongs!

realitybiter's picture

Nothing new here

Thanks for the post. "Nothing New" is a reference to past implosions of behemoths. Martin Armstrong HAS been a good researcher on Rome. Forever, folks have inferred that the Barbarians at the gates overtook Roman farms. (what else could have happened?) And mighty Rome fell due to being overpowered....the reality, it seems, is that folks left their farms before the barbarians got there. Taxation became so onerous as Rome rung up more bills than it could pay - that folks went Galt. They simply walked away and the new owners came in some time later finding abandoned farmland....

and so China watches as the US screws itself into oblivion. Fight stupid wars that have zero economic or political benefit (for the US). Create social welfare that forces producers to seriously consider why they produce and then quit producing. Voila. In the 21st century, the Chinese, overtake the US, finding abandoned businesses...and happily take over this role of production...

It is obvious. and painfully sad, realizing what this means for future US generations.

This is not the first rodeo for mankind.

On a side note, speaking of Rome: I received my discontinuance notice from my health insurer last week. Apparently, they lost the first notice and told me I had until tomorrow to make plans for my family's future. My choices are either "obamacare" or their replacement policy, which is an increase of 140% in premium, for a policy I don't want. Benefits are similar to the last policy. I went to the State ran website. Loaded my info on 3 times, all 3 times this info was scrubbed entirely when I hit the "continue" button. It is impossible to get insured through the Obamacare site in my state. It is not a choice because they haven't figured out what Amazon or Etrade figured out 15 years ago!! Yesterday, the Exec Director of the State program quit, due to health reasons.....right....

My wife says I get too angry about this. I chide those that voted for this and I am told that I should not get so excited. I respond, "how the hell else is a democratic republic supposed to function if we don't have lively debate???" "you people are too lazy. You are the reason why things are so screwed up!" My point is that folks that come on the airwaves and say, "Obamacare is fine, this is just right wing BS, are LYING. It is a mess here on the ground.

The insurance companies are loving it. They just gave themselves a huge raise in premiums, and reduced their expenses. Free market in action!

So, there is a very good chance I will be going Galt for insurance. Why not? It is a 1% tax on your stated income. Insurance co loses, Obamacare loses, and I keep on spending what I normally do on healthcare -zero. The Roman farmer quit producing wheat, and the American citizen quit producing income.....peace!

Dr Jerome's picture

What a debate...

After making a modest purchase last night, My wife and I debated making a larger purchase this morning. Are we looking at another loss by spring if we buy more silver? How can it possibly stay below the mining costs for long. Why keep sitting on this pile of dry powder in the desk drawer--how is that benefiting us?

Will I kick myself in the arse harder if I make the purchase and it goes down 20% further, or if I pass on these prices and the markets fall apart before I have a chance to buy more low-priced metal?

For me, the regret is greater when I DON'T do something than when I did and failed. I have started and failed at a couple of businesses, losing lots of currency in the process. I don't regret it.

But I looked at table of culled Morgans for sale for just a few dollars each at an antique store in 2001 and shrugged my shoulders and walked away. Regret!

Why are we even having this conversation in our home with $19 silver and $1220 gold? TPTB has really twisted my brain--and I count myself as one who knows a bit about what is really going on in our world economy.

I think I'll throw out lot in with the Asians rather than the West.

So we pulled the trigger, for better or worse in the short term. For better in the long term. I am sure thankful that my wife and I are on in agreement about metals and investing.

Having a stack of these on the way feels good this morning.

Well, I better stop reading about metals and grade papers for my classes.

Happy stacking this week. May you all be blessed and prosper and may metals break free of manipulation and return to their true value.

silver66's picture

Unwired--GPS

You are new to the site...Welcome.

You have posted an article that is another way of describing Freegold as being put forward by FOFOA and Jim Sinclair.

It is a well written piece.

Make sure you are stackin

Silver66

Turd Ferguson's picture

Excellent work Pining.

MODERATOR

Well done!

Green Lantern's picture

Sorry about the triple

Sorry about the triple posts.  I was having some problems with computer and posting and didn't think any of them posted. 

Quixote2's picture

China gold price

the page will not take cut and paste for me.............delete this comment.....

meegoreng1's picture

China

The Chinese Govt is nothing more than pawns of the EE. It astonishing to hear China being a separate entity and they could decide the fate of the Pig aka the USD on their own. 

If China does declare their gold holdings and announces gold backed yuans in the future which I highly doubt,  it will be with full blessings of the EE. Remember the corrupt Chinese central bank just like the FR has vested interest to keep creating their ponzi filled paper currencies for as long as they can.

realitybiter's picture

mining costs

In the mid 80's, my Dad and I were talking about gold. I was in my mid-20's and very much engaged in the PC technology boom....He asked me what I thought about gold price and I said, "what's the mining cost?" He said "250-300?" I said, "that's where it will go..." and so it did.
Today, we are at the same price...there is very little downside here. It is like buying Apple stock for the cash in the bank, back when they had a stable PC biz and a few $B in the bank, and no ipod.....

beeep, beeeep, beeep...

I don't know what direction the next 100 dollars in gold are going, but I am pretty sure of the next 5 or 10 thousand dollar direction....

Clarki Stomias's picture

Does China's Own QE Dampen This Somewhat?

I follow you Pining, and I think your conclusions follow your reasoning.  It is best for China to wait out the US's self inflicted wounds and that is probably what they will elect to do. 

What I have been stuck on lately is China's own printing of $15 trillion.  You said they could fractionally leverage their gold up to 8-9 trillion.  That still puts them only about 60% there.  I think that all global economies will suffer a meltdown.  Including China.  But whomever has the most real assets will come out the other end the strongest.  I agree with you that that still should be the land of the dragon, but I think the path to that destination will be filled with unavoidable chaos for all, even China.  And it may impede them from being the sole reserve currency.  It maybe a basket of gold backed currencies, as Sinclair has stated, led by China. 

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