Statements issued by the US Federal Reserve and the Central Bank of the People’s Republic of China today sent live gold prices plummeting. The yellow bullion opened at $1335.50 Wednesday, but nosedived to $1331.80 at 14.00 New York time as news of Janet Yellen’s plan filtered through to the trade floor.
Yellen confirmed the Fed would continue tapering its QE stimulus and has shaved bond spending to $55bn a month. The Fed chairwoman, appointed on 1 February this year, also announced intentions to keep interest rates low despite the recovery of the job market. This is not good news for equity investors. As a result US share fell.
Gold prices had already fallen in Asia after the as China issued warnings against defaulting companies and pledged to develop a market-driven economy. Having recently been rocked by default payments of metals, China’s unregulated shadow banking system has been exposed and threatens to drag the People’s Republic into depression.
China plans for financial future
For a long time now, the Chinese government has turned a blind eye to companies that use metal investments as a hedge against lending. It is a practice that has been widely deployed in China for more than a decade, but has recently exposed a weakness in the Chinese economy.
China’s central bank has now issued a warning to corporations that it is changing its financial reforms and there will be no more bailouts for companies that default on payments to investors. With more company defaults and bankruptcy applications expected in the coming months, Chinese debt is expected to slow the growth of the economy.
By developing a healthier credit market, borrowers and lenders will be encouraged to act more responsibly. However, allowing companies to fail is fraught with risk as it undermines social stability in the face of a diminished economy. But an economy with slow growth is better than a country stifled by a credit crunch.
The central bank of China also announced its intention to double the trading range of the yuan against the dollar from a mid-point range that would be fixed every morning. Although this will make the value of the yuan fluctuate heavily it loosens the currency controls which will attract foreign investment.
The long-term potential of promoting a flexible two-way system should attract more capital from offshore funds and boost the confidence in the yuan – something the Chinese government is determined to do. As the world’s second largest economy behind the US, policymakers in the Republic want to usurp Washington as top dog.
With the US dollar in such weak form, the latest directive from China’s central bank could position the yuan to replace the greenback as the world’s default currency. If the dollar collapses the global economy will spiral into ruin – unless there is a ready-made default currency in place. The yuan is not there yet.
The good news for investors looking to add precious metals to their portfolio is that gold prices have dropped to $1331.80 an ounce and are expected to fall further as the global economy recovers – regardless of how slow the recovery is!