China’s recent massive sell-off of U.S. government bonds has financial headlines buzzing. This unprecedented move comes on the heels of President Biden’s decision to hike import tariffs on various “strategic” goods, including electric cars, by a staggering 200 to 400 percent.
The implications are clear: China is pivoting away from the U.S. dollar and turning back to gold. And they’re not alone—countries like Poland, Turkey, and Russia are also amassing gold reserves. The chart below, straight from the IMF (apologies for the less-than-stellar quality), illustrates this trend.
Shift to gold
While China’s foreign exchange reserves still heavily feature the U.S. dollar, with a weighting of over 30 percent compared to less than 5 percent for gold, the landscape is shifting. China now conducts more trade in its own currency than in the dollar, a trend that isn’t surprising considering many global currencies are pegged directly or indirectly to the dollar.
If diversification is the goal, gold is the prime candidate. Its history as a monetary standard, coupled with its substantial market capitalization—now over $18 billion following recent rallies—makes gold an ideal asset for rebalancing foreign exchange reserves without significantly disrupting the market. Imagine attempting this with Bitcoin.
Protecting the yuan
While headlines might suggest the dollar is on the brink of collapse, an immediate implosion is unlikely. Part of China’s bond sales can be attributed to the significant pressure on the yuan. Factors such as the Federal Reserve’s interest rate policies, ongoing issues in China’s property market, and lower domestic interest rates—China’s 10-year rate is over one percentage point below the U.S. rate—are straining the yuan. Selling dollar-denominated bonds helps alleviate this pressure.
‘Milkshake theory’
Enter the “milkshake” theory: to sustain an ever-growing debt, the system requires increasing liquidity. As the issuer of the world’s reserve currency and home to the largest, most liquid bond market, the dollar “slurps up” all that liquidity, like a milkshake. This makes the dollar the “cleanest shirt in the dirty laundry.”
Given the risks associated with global debt, where would you hide? The euro? The yuan? The dollar’s dominance may not be eternal, but it’s not crumbling overnight either. That doesn’t mean you need to cling to the dollar, but its position remains formidable.
Jeroen Blokland, founder and manager of the Blokland Smart Multi-Asset Fund and former head of multi-asset at Robeco, shares his insights weekly on Investment Officer. (Disclosure: The Blokland Smart Multi-Asset Fund has included 25 percent gold in its strategic asset allocation.)