China reserve currency bid could boost gold-report

BEIJING, Jan 11 (Reuters) - China's anticipated rise to reserve currency status could boost gold's role in the global monetary system, although a return of a "gold standard" to which paper money is tied is unlikely, according to a new report from a central banking think-tank.

The shift over a decade from today's dollar-dominated global monetary system to a multi-currency environment that includes China's yuan would likely trigger a rebalancing of Beijing's own $3.2 trillion reserve assets that would see other central banks follow suit, said the report from the London-based Official Monetary and Financial Institutions Forum (OMFIF).

"A reserve currency country is unlikely to wish to spend funds building up assets that are someone else's liability," said the report, noting that the shift to a multi-currency reserve system would likely bring with it substantial volatility in foreign exchange rates as a new global equilibrium was found.

"That is where the attraction of gold, an asset which is nobody's liability, should stand out: investing would denote no political bias and should minimise foreign exchange fluctuations. For central banks concerned with preserving value and naturally politically cautious, gold is likely to prove a haven from currency storms."

China is widely regarded by analysts as holding too little gold in its reserves, particularly relative to the issuers of the two current dominant global currencies - the U.S. dollar and the euro.

Data from the World Gold Council, which commissioned the OMFIF report, shows China held 1.6 percent of its official reserves in gold as of July 2012.

That compares with 74.5 percent in the United States and 71 percent in both Germany and France - the anchors of the euro currency - as of the end of 2011.

The report gave no recommendation for how much gold China should hold, or how much of global reserve holdings the precious metal was likely to comprise in the multi-currency system envisaged, but it did highlight the risks of a shift and the consequent limitations of gold's future role.

Limited supply, the likelihood of sharply rising prices as central banks rebalanced gold holdings and the unwillingness of reserve currency issuers to abandon the flexibility of being able to issue new securities at will would all prevent a return to a gold-backed monetary system.

"We will probably never see the return of a fractional Gold Standard," the report said.

OBSTACLES TO RESERVE STATUS

Meanwhile considerable obstacles also remained to be overcome before China's currency could play a greater role in the global reserve system.

A reserve asset must generally meet three key tests - be fully convertible, provide plentiful liquidity and be a store of value that investors wish to hold - and many analysts say China's yuan currently passes none of them.

Many central banks are forbidden by statute from holding a reserve asset that is not freely convertible, making China's capital controls a crucial barrier.

But increased yuan use in direct settlement of cross-border trade and the burgeoning offshore market in yuan currency trading and bond issuance was beginning to change that, OMFIF chairman, David Marsh, told a seminar launching the report.

Private sector trade settlement in yuan still required central banks to raise money in the offshore yuan market to match liabilities with assets in official reserves, Marsh said.

"Private market issues are very, very important and history teaches us that private markets can help drive reserve currency use. It's not what governments or central banks really want to do, it's what the markets are telling them they would wish them to do," Marsh said.

"Central banks are asking the Chinese authorities to move more quickly and more transparently."

(Reporting by Nick Edwards; Editing by Kim Coghill)