Deposit Insurance Will Increase Gold Demand in China

Within 2014 the State Council aims to implement a new deposit insurance system for its banks. While one might think this is meant to lower systemic risk, it’s actually meant as a step to shift risk from te government to its citizens. Handing the people the opportunity to be more responsible for their own financial health, introducing more laissez-faire. I present a translation from a Chinese commentator on this matter, published on March 21, 2014.

Notes from the translator, LK:

The fact the Chinese government is pushing to introduce a nation wide deposit insurance system in 2014 tells a lot; according to the author, we are in an environment of heightened financial uncertainty and default risks. As the West moves for bail-in legislations, the Chinese are heading in the opposite direction.

As Western economies become more and more policy and stimulus driven, socialist China is becoming more market driven, preparing to withdraw official support and let defaults occur to clean up malinvestments and unviable businesses. The first corporate bond default in history happened past February (2014).

Efforts to carefully move towards market driven mechanisms are introduced to the people as government guarantees will slowly be withdrawn, depositors are stimulated to investigate and seek ways to protect themselves.

The defensive nature of gold in the face of defaults is highlighted. This article concerns depositors, but we should be on the watch for signs that banks themselves are encouraged to hold gold as hedge against financial risks: for this hedge to be effective, the value of gold must rise by a large magnitude to make up for any such systemic losses – if official bailouts are to be avoided. This would mean that a large rise in the price of gold is implied in the policy!

Deposit Insurance System Will Increase The Demand For Physical Gold In China

2014 March 21

Author: Liu YuXiang, Research Director, Shandong Zhaojin investment company ltd.

March 5, Premier Li Keqiang in his government work report suggested that one of the main tasks this year is to deepen financial reform, including “the establishment of a deposit insurance system and improve the mechanisms of risk management for financial institutions." On March 10, central bank governor Zhou Xiaochuan also said the deposit insurance system will be launched within 2014.

“Compulsory insurance", “bounded compensation" and “different rates for different risks" are important aspects in the design of the deposit insurance system. Bounded compensation meaning that a policy holder will receive compensation in full if the amount is within the stipulated limit. With the introduction of the deposit insurance system, depositors, for the first time, will face the reality that bank deposits may not in fact all be safe and secure.

The limited compensation feature in the deposit insurance system is expected to have bullish effects on the price of gold. In the minds of the Chinese people gold is a hard currency, the asset of minimal risk. For a long time, under the planned economic system, China’s banks were not only riskless but also payed interest, hence the preferred investment channel for many. Under the socialist market economy bankruptcy has become accepted by the public not only in theory but also in practice. Subsequently this particular commodity currency, gold, operating for the potential risks of commercial banks has also been accessible to the public. The deposit insurance system will hike the risk awareness to the general public, with the market speaking out the fact that banks may indeed collapse as the official safety guarantee is withdrawn. People will also start to recognize the message that there are other ways and places, apart from banks, in which they should consider putting their money.

Gold is the most well known strategy against risk and is well recognized by ordinary Chinese people. The insurance safety guarantee may be set at RMB 500,000 which covers more than 99 % of the accounts. The deposits greater than this amount may go seek a type of capital guarantee investment. Although the gold price is now near a two year low, compared to other investment asset classes such as stocks and bonds, gold still has a considerable advantage; in times of heightened financial risk gold should perform better than other asset classes.

Gold is an effective hedge against counter-party risks in deposit losses. After the launch of the deposit insurance policies, those not covered by the insurance guarantee will naturally be more aware of risks and will likely shift some assets into physical gold so as to guard against deposit defaults. Moreover, gold’s high value, stable physical properties and easy storage should make gold a first choice for wealth preservation purposes. Hence, the policy of the new deposit insurance system should raise China’s demand for physical gold, and is bullish for the gold price.

Gold’s safe haven attributes has received fresh attention recently as capital markets have become jittery again: The “11 ChaoRi" default is the first interest bearing corporate bond default in history, and it’s likely to be a first, not a last. More cases of default will definitely have an impact on global capital markets. After “11 ChaoRi", copper and iron ore prices plunged more than 9 percent, global mining stocks took a dive, followed by market indices. The RMB has also lost value.

Let’s review the history of the United States deposit insurance system. In the 1930s the United States passed the Glass-Steagall Act in order to save the banking system, in 1933 the government established the FDIC bank deposit insurance agency. The deposit insurance system came into operation in 1934 to ensure stability, it was the the world’s first system of this type.

The Chinese economy is facing a lot of problems and we must establish a sound financial and social safety net as soon as possible, preferably before any banking problems surface because prevention is the best crisis management policy. We can see from the tumbling prices of various industrial raw materials and the loss of value of the RMB that China’s economic situation isn’t doing well. In all this, however, gold has stayed firm for the last 3 months. In this environment, the introduction of the deposit insurance system should be expected to push up the safe haven demand for gold.

In Gold We Trust