By Nomi Prins, Editor, Inside Wall Street with Nomi Prins
Welcome to our Friday mailbag edition!
Every week, we receive fantastic questions from your fellow readers. And every Friday, I answer as many as I can.
But before we get into our questions today, I want to put an upcoming event on your radar.
This week, we’ve written about the energy crisis unfolding globally. And we’ve shown you why America’s energy infrastructure needs an upgrade.
That’s why my team and I have been looking for new energy trends… and ways we can turn this crisis into an opportunity.
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Now, back to our questions.
Up first today, a question from reader Terry on the gold holdings of Russia and China… and how this affects their plan to replace the U.S. dollar as the world’s reserve currency…
We often hear how Russia and China are buying gold and how they may form a new currency basket to replace the U.S. dollar. My brief research indicates the U.S. holds almost twice as much gold as Russia and China combined. Is either of these currencies convertible to gold?
U.S. gold reserves are said to be 79% of U.S. central bank holdings; China’s gold reserves are 3.5% of central bank holdings. What is that telling us?
If the yuan exchange rate does not float, is it still a viable world reserve currency?
– Terry
Hi Terry, thank you for your terrific questions.
You’re absolutely right, the U.S. holds almost twice as much gold as Russia and China combined.
As of 2022, China reports total gold holdings of 2,011 metric tons and Russia reports holdings of 2,299 metric tons. Whereas the U.S. had 8,134 metric tons in the fourth quarter of 2022.
Admittedly, both countries can be “opaque” in their reporting. So we can’t know for sure how much gold they have. But these are the official figures as of writing.
Now, the short answer to your question is no, neither the ruble nor the yuan is convertible to gold.
But there’s some fine print…
In China, the story is a bit more complex because you can convert yuan into physical gold if you trade crude oil futures.
The backstory is that China originally launched its crude futures contract on the Shanghai International Energy Exchange back in March 2018.
This enabled any oil producer in the world to sell its oil for the Chinese currency, giving birth to the petroyuan.
But there was one problem. Most oil producers don’t want to accumulate a large yuan reserve. China knew this.
That’s why it explicitly linked the crude futures contract with the ability to convert yuan into physical gold. That’s without touching China’s official reserves, mind you… but through gold exchanges in Shanghai (the world’s largest physical gold market) and Hong Kong.
But that doesn’t mean the yuan is backed by gold.
With a fully backed currency, you can go into a bank and exchange your paper money for gold or silver.
For any country to do that, it must have sufficient gold reserves to provide ironclad backing. And with China’s gold reserves currently standing at 3.5% of central bank holdings – as you pointed out – it simply doesn’t have enough gold.
What about Russia?
After all, the country boasts some of the biggest shares of central bank gold reserves, making up roughly 20% of global reserves.
But don’t hold your breath about it becoming convertible to gold any time soon.
The only reason anyone would ever want a gold-backed ruble is if they wished to exchange it for gold. It’s not like Russia is able to produce goods and services that would be competitive in the global markets at this stage.
This means that a gold-backed ruble would quickly lose its shine. The Russians would exchange it for foreign goods only to see foreigners turn around and exchange it for Russian gold. Pretty soon, Russia would find itself having traded its stockpile of gold for a basket of Western goods and services…. and the gold-backed ruble would be no more.
Now, onto that last question…
If the yuan exchange rate does not float, is it still a viable world reserve currency?
This question is related to why the petroyuan hasn’t yet dented the dollar’s dominance in any meaningful way…
As I’ve mentioned before, oil-producing countries need to be able to invest all the money they receive for their exports.
And no matter how many yuans you have, you can’t easily use or invest them anywhere outside China.
That’s because, unlike the U.S. dollar, the yuan is not a freely convertible currency. Meaning, its value is not determined by the market forces of demand and supply. Instead, its exchange rate against other currencies, including the U.S. dollar, continues to be managed by China’s central bank.
And with China, that’s a massive political risk for anyone to take. And it’s why the yuan hasn’t caught on with international investors.
Now, none of this is to say that China’s efforts to undermine the U.S. dollar’s status as a global reserve currency are not worth paying attention to. They are. But the greenback is not getting dethroned any time soon… and it’s not something that will happen overnight.
In the meantime, as I’ve been saying, the biggest threat to the U.S. dollar remains the Federal Reserve.
But if you still do not feel at ease… I suggest you consider getting some exposure to gold.
The metal is the ultimate form of wealth insurance. It has preserved wealth through every kind of crisis imaginable. You can’t “dethrone” gold… You also can’t “print” it.
Investment in gold can be physical, or it can be in the form of exchange-traded funds (ETFs) or even gold mining stocks.
I covered this in more detail in some of our mailbag issues. If you didn’t catch them or want a refresher, read up here and here.
Reader Terry also raised another good question:
If a U.S. CBDC is fully implemented, what happens to all of the dollars held in cash outside of the U.S.?
– Terry
At the moment, the Fed itself isn’t even providing an answer to this question on its CBDC Q&A page… But first, you should know that the Fed is engaging in a “multi-year exploratory research project” on issuing a CBDC that could be used by an economy as large as the United States.
Of course, this is alarming. It signals the Fed’s intent to do just that – use a CBDC for all economic transactions in the United States.
Now, onto your question: how would a CBDC affect the dollars held outside of the United States, let’s say by central banks, banks, or asset managers? Well, the Fed would eventually replace these dollars with CBDC as well.
In practice, the Fed could create some sort of electronic transfer mechanism to make this transition. Central banks or global asset managers would electronically convert their physical dollars into CBDC. And they’d be incentivized through a deadline to do so.
We don’t fully know how this would impact the value of the U.S. dollar. But one thing is true: with a CBDC, it’s easier and quicker for the Fed to create money. This could negatively affect the U.S. dollar’s value relative to other currencies. Yet, there are so many other economic or geopolitical factors that could impact the value of the dollar. So only time will tell.
It will take years for a CBDC to go into effect, given all the logistics involved. But once the CBDC is up and ready, it could mean you can’t use any cash anymore. And the Fed and government will have insight into all of your financial transactions.
Next, reader Gordian wants to know how a CBDC would be controlled by the government, and how it would affect the debt ceiling…
We are told that our system of government, such as Congress, controls the purse. Under a CBDC, how would this work if the central bank can continuously print more CBDC dollars? How does this affect the debt ceiling?
– Gordian B.
Hi Gordian, I’m so glad you and other readers here are asking these important questions about the Fed-controlled CBDC. You see, replacing our dollar with a CBDC is the biggest change to our money and financial way of life since the Fed was created in 1913.
First, Congress “controls the purse” because it’s tasked with confirming the annual budget for running the economy. It’s also tasked with decisions about the size of the U.S. debt ceilings – or the amount of borrowing that the U.S. is allowed to do to meet its existing legal obligations.
As we’ve written before, these obligations include paying interest on already issued U.S. debt and making good on social security and Medicare payments, among other things. If there’s not enough money coming into the U.S. Treasury in the form of tax revenues (from domestic and foreign sources), we’d need to borrow more.
But you see, we haven’t been great at managing our own budget. That’s why the debt ceiling keeps getting raised, even if there are lots of political fights about that along the way.
Now, technically, the Fed, which would oversee a CBDC, can print more money whenever it wants to. That’s because there’s no congressional or legal limit to how much printing it can do. And in return for that printing, under the process of Quantitative Easing (or QE), the Fed electronically creates money. It can then buy U.S. government debt with it. (For more details, I’ve written about the process of QE and how it works here.)
But with the way things are right now, the Fed would buy U.S. government bonds with that printed money from market players. These include big Wall Street banks. And it wouldn’t be directly from the U.S. Treasury.
I believe that a CBDC-based system would open up a more direct channel for the Fed to buy U.S. government debt. They have not said this, but it’s a logical step for the Fed to have more control.
And that ease of creating more CBDCs to buy debt would lead to more debt creation and more debt ceiling hikes. That’s because the Fed would have the ability to buy that debt more easily and directly. This will prove that no matter how much debt it creates, the Fed will be there in some capacity to buy it.
But here’s the scariest part about a system like this. It has the potential to connect every financial transaction we make directly to the Fed. And that means that the Fed and government will have control over our money and how we use it.
If you’re concerned about protecting your privacy and financial transactions, it will be important to invest in hard assets that have exchange value such as gold.
Finally, our last question this week is from reader Warwick on the existence of a yuan-denominated gold-backed bond…
I understand and agree with your reasoning, in your reply to Linda M., in regard to why the yuan cannot currently replace the U.S. dollar as the world’s reserve currency. But I thought China had created a yuan-denominated bond that was freely convertible to gold. Wouldn’t that resolve most of your objections?
A few years ago, there was an idea being put forward by people who have a similar mindset to yourself that the U.S. dollar would be replaced by the IMF’s SDR as the world reserve currency. Would the SDR be re-denominated based on the gold reserves of each country, which would have to be independently audited? Is this idea no longer fashionable?
– Warwick G.
Hi, Warwick. Thanks for your thoughts and questions!
One thing to keep in mind when we’re talking about the PRC (short for the People’s Republic of China) is that very few things are done “freely” over there…
It’s true that China has been taking more steps to open its $20-trillion bond market to foreigners. Things like improving overseas access, streamlining the process of opening accounts, and reducing foreign investors’ costs, among others.
But a yuan-denominated gold-backed bond has not been one of those things.
If I had to guess, you might be referring to gold-backed crude oil futures in Shanghai and Hong Kong.
As you may recall, the launch of these contracts back in 2018 created a new non-U.S.-dollar benchmark for the price of oil. It also gave oil market participants the ability to convert their yuan into physical gold.
This really happened. And it just goes to show that the U.S. dollar has competition… And while I do not think the dollar is in immediate danger, it’s worth keeping an eye on any significant developments.
China’s warming ties with Saudi Arabia – which you mention – are a case in point.
As I wrote in my reply to a reader’s question about this same subject, if Saudi Arabia begins conducting its oil business with China in yuan, it would be a smack in the face for the dollar.
That would lend significant weight to the yuan worldwide… That’s even if these sales didn’t extend to all the countries in the Shanghai Cooperation Organization (SCO).
But, then again, you must remember that oil-producing countries need to be able to invest all the money they receive for their exports. They need deep and transparent capital markets. They also need the ability to move money in and out of a country easily. And China is just not there yet.
Now, to answer your question about a gold-backed SDR…
Short for the Special Drawing Right, SDR is an interest-bearing international reserve asset created by the International Monetary Fund (IMF) in 1969.
The idea was that it could supplement the official reserves of its member countries.
Now, back in the day, the U.S. promised to convert any dollars brought to it by other countries into gold via the Bretton Woods System.
In essence, the entire Western financial system was pegged to gold, via the U.S. dollar.
So, the IMF defined the SDR as equivalent to a fractional amount of gold that was equivalent to one U.S. dollar.
In other words, as a unit of account, the SDR began life as the equivalent of the gold content.
But in 1971, the Bretton Woods System came to an end.
At the time, the U.S. gold stock was dwindling. The U.S. reached a point where it didn’t have enough gold reserves to cover the amount of foreign-held dollars. And President Nixon feared a run on our gold stock.
So on August 15, 1971, he closed the international gold window.
After that happened, SDRs basically entailed no benefits for the U.S. And our government had no reason to favor a substitute for U.S. dollar holdings in global reserves. It’s my belief that had the SDR not come into existence in the ‘60s, it probably would have never seen the light of day at all.
Today, SDRs still serve their original purpose as a supplement to foreign currency reserves, but less so after the ‘70s. Countries can hold their SDRs as reserves or exchange them for hard currencies with other IMF members on a voluntary basis.
Could they ever replace the dollar as a global reserve currency?
Yes, but only in theory. Given the strength and wide use of the dollar internationally, this is not likely to happen any time soon.
And that’s all for this week’s mailbag. Thanks to everyone who wrote in!
If I didn’t get to your question this week, look out for my response in a future Friday mailbag edition.
I do my best to respond to as many of your questions and comments as I can. Just remember, I can’t give personal investment advice.
And if there are any other topics you’d like me to write about, I’d love to hear from you. You can write me at [email protected].
Happy investing… and have a fantastic weekend!
Regards,
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Nomi Prins
Editor, Inside Wall Street with Nomi Prins
P.S. Right now, many of you are concerned that the U.S. dollar could be replaced. And as we showed you above, that’s very unlikely to happen anytime soon.
But there’s another pressing matter that poses a threat to America’s power. You see, America is dependent on other countries for our energy infrastructure.
But there’s a new subsector of energy – “SMR” – that could help America gain its energy independence. And during my Power Shift 2023 event on Wednesday, May 10 at 8 p.m. ET, I’ll explain how this is possible.
I’ll also explain how if you get in before this story starts making headlines, it could hand you as much as 20x your money in the long run. Reserve your spot for my special briefing with one click here. You have nothing to lose and everything to gain.