Should China increase its gold reserve?

Hu Xiaolian, vice governor of the People's Bank of China and head of the State Administration of Foreign Exchange, recently said China now has 1,054 tons of gold in its reserves, making the country the world's fifth largest holder of gold.

Some analysts hailed the gold reserve boost as a good solution to problems posed by holding too high a proportion of US dollar-denominated assets in China's colossal foreign exchange reserves. But others say that, as an investment product, gold may fail to function the way optimists expect it to.

Should China increase its gold reserve?

Yes

Ma Guangyuan, Chinese Academy of Social Sciences:

The Chinese economy is hostage to the real estate market at home and to the US dollar abroad.

China has become the largest holder of US government debts, with US Treasuries accounting for 70 percent of China's foreign exchange reserves. It will be hard to keep these assets from devaluating in the short term, given the dollar's depreciation and the potential for its position in the international monetary system to weaken, let alone get some sort of return in the long term. Such an asset structure exposes China to real dangers, even without the global financial crisis.

China's gold holdings remain disproportionate to its foreign exchange reserves and its comprehensive national strength. China overtook South Africa to become the world's largest gold producer in 2008 but its consumption and trade volume of gold is still quite low.

China should not only increase the proportion of gold in its foreign exchange reserves but also make gold one of the major forms of wealth among its people. The value of the country's foreign exchange reserves would be maintained or even increased and a solid foundation would also be laid for the yuan to become a reserve currency and a currency widely used in international trade.

Some people may think China has missed its best opportunities to boost its gold holdings, since the price of gold has already surged due to the credit crunch and world economic recession. They are concerned that if China buys gold now, it could face losses later since gold prices tend to fluctuate.

But world economies are likely to continue to be hurt by inflation and the depreciation of the dollar. Gold prices may have just started to rise. China may have lost the best chances in the past but now is not a bad time to buy gold.

Zhou Junsheng, commentator on economics and finance:

Gold plays a special role in stabilizing the economy, curbing inflation and enhancing a country's international credit standing. In the past 30 years of reform and opening up, China has significantly expanded its foreign exchange reserves, but maintained a relatively low level of gold reserve.

The ongoing financial crisis has proved that gold reserves still have an important role to play in our economy, as the US dollar, a sovereign currency, is inevitably subject to restrictions posed by the economic situation in the US.

The US' attempt to salvage its economy by going on a stimulus spending spree may accelerate depreciation of the dollar and threatens the safety of China's dollar-denominated assets. China should boost its gold holdings.

No

Fu Yong, cnstock.com:

The current strategic status attached to gold is too high and ignores the historical trend.

The 20th century witnessed the collapse of the gold standard system. Countries that gave up the gold standard recovered from the Great Depression faster than those that stuck to it and no country showed visible signs of recovery while adhering to the system.

Internationalization of the yuan needs support from a certain amount of gold reserves. But unless the yuan becomes a major international reserve currency, China does not need to significantly raise its gold holdings. Gold has no special advantage in liquidity or acceptability over major world currencies when it comes to making payments.

Gold can be an effective kind of insurance tool to fend off risks in extreme circumstances. But such conditions are rare and should not be the dominating factor in policymakers' decisions.

A Xi, a financial commentator based in Shanghai:

China's current gold holdings would be worth just a little more than $35 billion if the gold price were at its historic high of $1,000 an ounce.

China's gold reserve has expanded slowly over the past six years compared with the pace at which its foreign exchange reserves have grown in the same period.

If China bought all the gold (more than 8,000 tons) held by the US, which is worth about $280 billion at most, it would absorb only one-ninth of China's nearly 2-trillion-yuan foreign exchange reserves. The country would still face the same problems about what to do with the bulk of its reserves as it does now.

It would also be impossible for China to boost its gold reserve to more than 8,000 tons in a short period of time. There is not enough gold produced domestically and if China went to the international gold spot market, gold prices would skyrocket, making it hard to buy a large amount.

Even Hu Xiaolian's briefing on China's gold reserve sent gold prices up on the international market the same day.

Gold may not help maintain or increase the value of China's foreign exchange reserves. Gold prices have fluctuated around $500 an ounce over the past three decades, with a low of a little more than $300 and a record high, which came last year, of $1,000 an ounce.

It is unclear whether gold or US Treasuries had higher yields over the past 30 years. Unwise investment in gold could be even more dangerous than buying the Treasuries.

(China Daily 05/11/2009 page2)