China Rate Hikes: What They Really Mean for Gold

I have repeatedly come across the same headlines in the media regarding Chinas rate hikes are bearish for gold. There are several reasons why this couldnt be further from the truth, two of which I consider to be very obvious and able to be deduced via basic logic, yet overlooked by the mainstream.

The first, which I wont focus on in this article, is the fact that the real rate of interest is still negative. The second is much more obvious, yet the continuous banter from the masses indicates they have a complete lack of deductive reasoning ability. So the story goes that Chinas rate hikes are bearish for gold, as they will prevent inflation. But lets rationalize these rate hikes and their effects and revisit this statement.

How does a central bank hike rates? It sells bonds (treasuries) to the public, thereby contracting the supply of money (a.k.a. open market operations). But because the yuan still retains a rather hard peg to the USD, central banks are then limited in their ability to hike rates to any meaningful degree. Why is this? Selling a large quantity of bonds on the open market would contract the money supply, thus causing the purchasing power of the yuan to rise if the U.S. did not do the same. In other words, this would cause the yuan to rise against the USD, weakening the peg.

What are the effects of a rising yuan? In our case, because we have abandoned our manufacturing base

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