Hong Kong's rise as global gold hub boosts status of Chinese currency

The Chinese government has tried to internationalize the yuan and raise its stature as a global currency for decades. Hong Kong's ascension as a prominent yuan-denominated gold trading hub is giving that effort a big boost.

S&P Global Ratings managing director Charles Chang told CNBC that Hong Kong's evolution as a gold trading center and the ensuing elevation of the yuan's status could ultimately undercut the dollar.

“As those trading volumes grow, there would be a growing volume of the physical gold trade that is denominated in RMB and not linked in USD.”

Chang said the biggest challenge to internationalizing the yuan is finding places to use it. Hong Kong’s rapidly developing gold-trading platform coupled with Beijing’s aggressive gold buying creates such an avenue.

“In terms of gold particularly, if the RMB that the buyer receives can be converted to gold, then it gives more channels for the spending to be done.”

Hong Kong's quest to become a global gold hub

Earlier this summer, Hong Kong launched trial operations of a gold clearing and settlement system, putting the region in a position to challenge Western dominance of the global gold market.

The government-owned clearing system reportedly “mirrors” the financial infrastructure used by the LBMA in London.

When unveiling the system, Hong Kong Precious Metals Central Clearing Company CEO John Lee Ka-chiue said the company will offer “a comprehensive suite of services ranging from gold deposits and withdrawals to transaction settlements in the over-the-counter market in Hong Kong,” adding that a new gold price ticker – HAU – would be introduced to “ensure that Hong Kong gold prices are fully accessible to global market participants.”

To facilitate the clearing system, the Shanghai Gold Exchange (SGE) opened its first offshore gold delivery vault in Hong Kong.

At the time, Secretary for Financial Services & the Treasury Christopher Hui said that the SGE's decision to establish its first International Board certified vault in the special administrative region “offers international investors an option for delivering gold offshore, marking a key stride in the internationalization of the country's gold market, extending the global footprint of renminbi-denominated gold trading, and further strengthening Hong Kong's role in the regional market.”

Over the next three years, Hong Kong plans to expand its gold vaulting capacity from 150 to over 2,000 tonnes.

“If Hong Kong can complete this transaction, then it would become one of the largest gold trading centers in the world,” Chang said.

Last month, Hong Kong Exchanges and Clearing (HKEX) announced plans to launch a yuan-denominated gold futures contract early next year.

According to the South China Morning Post, the move aims to advance two priorities outlined in the city’s five-year plan announced last week:

• Promoting yuan internationalization
• Developing Hong Kong’s gold market

Chinese central bank Gold buying also boosts Yuan

Meanwhile, the People’s Bank of China continues the aggressive expansion of its gold reserves.

The Chinese central bank has reported an increase in its official gold reserves for 23 straight months, including a 23-tonne addition to its official holdings in September. This followed 20-tonne purchases in July and August.

Year-to-date, the People’s Bank of China has reported 80 additional tonnes added to its gold holdings.

And the Chinese have bought a lot more gold than that. According to data parsed by the renowned Money Metals researcher, the Chinese central bank currently sits on more than 5,000 tonnes of monetary gold in Beijing – more than TWICE what Chinese officials publicly admit.

Guotai Junan International chief economist Hau Zhou said this consistent gold buying “reinforces the credibility of the renminbi’s internationalization drive.”

“By steadily increasing gold reserves, Beijing is strengthening the long-term backing of its financial system and reducing reliance on dollar-denominated reserve assets. While gold alone will not determine the RMB’s global role, it enhances confidence in the currency and supports broader efforts to expand its use in trade, investment and official reserves.”

Nanhua Futures head of precious metals and new energy research Xia Yingying said gold accumulation by China and other central banks will “reduce global reliance” on U.S. Treasuries and dollar reserves.

“In the medium to long term, it will gradually weaken the U.S. dollar’s monopolistic position in the global reserve system.”

A problem for the U.S.

While the dollar won’t likely fall from its perch as a global reserve currency, even modest de-dollarization is problematic for the United States.

The U.S. depends on global demand for dollars.

The greenback’s role as the world's reserve currency is the only reason the U.S. can borrow, spend, and run massive budget deficits to the extent it does. It creates a built-in global demand for dollars and dollar-denominated assets. This absorbs the Federal Reserve’s money creation and helps maintain dollar strength despite the Federal Reserve’s inflationary policies.

A de-dollarization of the world economy could cause a dollar glut. The U.S. currency could further depreciate. At the extreme, global de-dollarization could spark a currency crisis. You and I would feel the impact through higher price inflation, eating away at the dollar's purchasing power. In the worst-case scenario, it could lead to hyperinflation.