Is Quantitative Easing Occurring in China Via Gold Purchases?

August 29th, 2011
in econ_news

Econintersect: The St Louis Fed points out that quantitative easing occurred in 1933 .

Few analysts recall, however, that this is the second, not the first, quantitative easing by U.S. monetary authorities.  During 1932, with congressional support, the Fed purchased approximately $1 billion in Treasury securities (half, however, was offset by a decrease in Treasury bills discounted at the Reserve Banks).  At the end of 1932, short-term market rates hovered at 50 basis points or less. Quantitative easing continued during 1933-36.  In early April 1933, Congress sought to prod the Fed into further action by passing legislation that

Follow up:

(i) permitted the Fed to purchase up to $3 billion in securities directly from the Treasury (direct purchases were not typically permitted) and, if the Fed did not,

(ii) also authorized President Roosevelt to issue up to $3 billion in currency.

The Fed began to purchase securities in the open market in April at the modest pace of $50 million per week.

In October 1933, the Fed started to get cold feet:

.....on October 12, these [Fed] officials unanimously approved a statement to the president noting that

(i) the System’s holdings of government securities exceeded $2 billion,

(ii) bank reserves had reached a record high, and

(iii) short-term money rates had dipped to record lows.

The Fed halted debt purchasing in November 1933.  But President Roosevelt believed more accomodation was necessary to kick start the economy.  Now the White House and Treasury eyed gold.

The Fed’s reluctance could be overcome with gold.  President Roosevelt controlled both the nation’s gold stock and monetary policy, so long as the Federal Reserve remained inactive. The president’s most effective tool was the Gold Reserve Act, passed January 30, 1934, which raised the value of gold from $20.67 to $35 per ounce. The mechanism by which the Treasury gained control was elegantly simple. On August 28, 1933, Roosevelt called all outstanding domestic gold into the Federal Reserve Banks; on January 30, ownership was transferred, before revaluation, to the Treasury from the Federal Reserve Banks in exchange for (paper) gold certificates. When gold’s price increased to $35 per ounce from $20.67, the Treasury realized a windfall profit of more than $2 billion.  The Treasury, Meltzer (2003) reports, began purchasing gold “immediately” via the issuance of additional gold certificates—bank reserves and the monetary base expanded when the gold certificates later were received by the Federal Reserve Banks.  During 1934-36, the Treasury purchased $4 billion in gold in international markets, sharply increasing bank reserves and the monetary base.

Being students of history, are the Chinese purchases of gold an alternate way for quantitative easing in lieu of buying its own debt documents?  Are sovereign gold purchases another way of keeping a currency correlated to the US dollar when the USA is buying its own debt?

It appears the Fed correlates sovereign gold purchases and sovereigns using their currency to buy their own debt - and both are called quantitative easing.

Going a step further, could the sovereign purchase of any hard commodity in excess of the use of said commodity be considered quantitative easing?

source: St Louis Fed


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  1. Derryl Hermanutz, Correspondent (Member) Email says :

    I think the main form of QE China practices is within its state owned banking system. China is a mecca of business entrepreneurship. Most of the factories are small businesses, and only a few ever become profitable and grow large and competent enough to service the export market.  

    The usual dirge associated with small businesses and startups is "undercapitalization", which really just means the entrepreneur only has his own meager savings to lose. Once his savings and personal credit are exhausted, his unprofitable business ceases operation. MAYBE after another year or two or five of losing money the business will become profitable, but 4 of 5 startups are out of business within 5 years so it's a bad bet that almost no profit seeking investors are willing to risk their money in. Hence "undercapitalization".

    But not in China, where state mandated banking policy is to keep rolling over and increasing 
     business loans. The businesses keep paying out wages to Chinese workers, but the owners never recover those labor (and other) costs by selling their outputs to that income. The goods are dumped into the domestic market where they are sold below cost. So Chinese workers enjoy incomes higher than their employer could afford to pay if he were subject to the profitability mandate of a private-for-profit money system; and those workers simultaneously enjoy consumer goods priced at "deflationary" below cost prices. Higher incomes, lower prices.  Good deal for Chinese workers. 

    This is the "extend and pretend" approach to QE, except there is no "pretending" required because the Chinese state owned money system does not labor under the deceptionthat bank loans must be repaid. Periodically the government sets up a "bad bank" to buy the underperforming loans from the lending banks, probably so bank managers don't fret over their ongoing insolvency, and also to satisfy international financial watchdogs/vultures who want the whole world suborned to their predatory private money system that makes the economy serve money, rather than money serving the economy.  

    China's banking system is designed to serve the "economic" needs of the Chinese people, which it does by keeping employers in business employing Chinese to produce goods that will be sold below cost. The ongoing operating loans function as subsidies to business, so owners can pay themselves even though they don't earn profits. The Chinese have figured out how to make their money system positive sum to match the economic system that adds "value". The rest of the world is enslaved by a banker owned money system that imposes negative sum money on a positive sum value creating economy, which inevitably produces bankruptcy and depression even when "the economy" is ready, willing and able to keep working and producing. 

    Banks issue the economy's "money" as loan principal. But banks simultaneously charge the economy with "debt" as principal plus interest.  "Money" to pay the interest does not exist, so the system systematically generates more debt than money. We have a "negative sum" money system where there cannot ever be enough money to repay all the debts and interest. 

    China's banking policy is pretty much exactly the kind of positive sum monetary system CH Douglas was advocating during the Depression, which he called "social credit", and which is a version of what is now called modern money theory. 

    Douglas saw that profit seeking business, like for-profit banking, is arithmetically impossible. Employers' "costs" are the economy's "income", so the national income is only able to pay the cost price of the national production. Douglas' social credit system involved subsidizing producers to sell their outputs below cost, so the economy could purchase all the output with its income AND enjoy some income left over to save. 

    The nitty gritty of social credit's subsidy and pricing mechanisms required the kind of omniscient and benevolent technocracy that the early 20th century believed was going to become reality in the modern 'scientific' world that would be ruled by engineers. That didn't happen, but Douglas' arithmetic analysis of our financial problems was exactly correct. Of course Douglas advocated government issuance of debt-free money, just like Chinese bankers are issuing to Chinese employers. A 'loan' that is never called in and never has to be repaid creates the equivalent of "debt-free money" for the economy. 

    I think China's gold purchases are intended to diversify China's fx holdings out of US$, not as a means of implementing a QE program. QE means the government creates additional currency. China can only create yuan. China cannot pay for gold imports with yuan. Payments are made in dollars. So gold purchases change the asset mix in the Bank of China's fx portfolio, but they don't add any new yuan into the Chinese economy so it is not a QE type operation. If the Chinese governmebt is creating yuan to buy domestic Chinese gold production, that would function as QE. But exchanging dollars for gold is not QE for China. 

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