The Chinese government is in a very difficult situation. The economy is cooling fast, may even move into a recession. The official growth figures appear ever more ridiculous and undermine the credibility of the Communist Party. Chinese stock markets reflect this. Even though most of the stocks on the Shanghai Stock Exchange are currently suspended, government influence has not been strong enough to stop the collapse in prices.
There is a serious underlying problem. A government can not have an independent economic policy if it pegs its exchange rate to a foreign currency. The peg submits the Chinese economy to the monetary regime of the Federal Reserve Bank of the USA. This conflict undermines trust in the currency. Outside China the Yuan is traded with a discount. Illegal flows of Yuan out of China are in the hundreds of billions per month (or in the tens of billions if measured in USD). It is estimated that the Chinese central bank supports the exchange rate CNY/USD currently with ca 100 billion USD per month. This currency regime - the peg to the USD - seriously undermines Chinese policies to stimulate the economy. Every lowering of the interest rates by the central bank, every relaxation of reserve requirements comes to naught because they just increase the amount of money fleeing the country and do nothing to relieve the credit conditions in the country. To regain sovereignty over her economic policy, China needs to move to a market supported exchange rate. Two options emerge. A free float, amounting to a devaluation (20 per cent as an educated guess), or underpin the Yuan by gold. The first move would lead to a loss of value to all Yuan holders, a loss of trust and an increase in prices in China. It would give Chinese exporters a temporary boost but other countries in Asia and elsewhere would devalue as a response (South Korea and Singapore probably on the very same day). The advantage would be short lived. The US would brand China a currency manipulator and obstruct Chinese imports. The Chinese people would suffers a loss of purchasing power if the Yuan devalues. This could cause social unrest. It appears that devaluation is not the best solution.
Moving to a Gold Yuan looks far more attractive. We all know that paper money is not really money - just currency. It is an IOU, born out of desperation when the world's governments defaulted on their debt in gold and decreed the use of printed pieces of paper as currency.
If China introduced the Gold Yuan it would gain enormous advantages. A Gold Yuan would stand above all other currencies and dethrone the USD as the world reserve currency. Nations, central banks, businesses, savers, would ditch the US Dollar and scramble to get hold of the Gold Yuan.
The Gold Yuan would probably trade at a premium to its gold backing, thereby earning the People's Bank of China a nice profit. With annual mine output of more than 400t China is the world's most important gold producer. They can dig enormous amounts of money out of the ground.
The introduction of the Gold Yuan will lead to an ever increasing demand for gold when this currency is snapped up by investors. The gold price per ounce will be north of USD 150,000 (Dec 2014 purchasing power) if only one per cent of all investments go into gold.
The Gold Yuan and the revaluation of gold would provide China with an enormous boost in official and private wealth. According to estimates, the Chinese government holds between 6,000 and 20,000t of gold. Chinese private gold demand has been rampant for years, in 2014 it was at least 2,000t, this year's demand is set for a 40 per cent increase.
The impact of the Gold Yuan on the Chinese economy will be very positive. The old Yuan will be exchanged into the Gold Yuan at an exchange rate that reflects the competitiveness of the Chinese economy. All contracts would be repriced in Gold Yuan. Inflation would fall to zero and interest rates would be very low, at two or three per cent. The stability that a gold currency provides, plus the prospect of generating earnings in the best currency imaginable will trigger enormous foreign investments. With it China will receive an unprecedented transfer of economic power and expertise. Silicon Valley would move lock stock and barrel to China.
There is no nation more fanatical about gold then India. The Indian government will find it extremely difficult to resist a call by the people to introduce the Gold Rupee to compete with China.
This could become a chain reaction spreading from China as ever more nations copy its currency.
Asia would enter a golden era.