Guest Post: The Exter Pyramid And The Renminbi

Submitted by Mao Money, Mao Problems

The Exter Pyramid and the Renminbi

The pyramid is the strongest structure known to Man. The weakest structure is the inverted pyramid. There is an economic theory called the Exter Pyramid to describe the financial system. It is an inverted pyramid ranking assets by risk. Gold, the safest asset, holds its place at the tip of the pyramid. Riskier assets, such as cash, deposits, bonds, stocks, real estate, non-monetary commodities, etc., take their respective place above gold.

When the pyramid gets top-heavy, it has to re-adjust itself by reducing the value of the riskier assets and increasing the value of gold and other less risky assets. Although finding the true value of the total Exter Pyramid for a country is extremely difficult, we can use readily available data from a few asset classes to understand a basic structure.

America's basic Exter Pyramid was worth USD 28.4 trillion (CNY 178.92 trillion), including gold. China's basic Exter Pyramid was worth CNY 126.1 trillion (USD 20.02 trillion) including gold. (In the charts above, gold was shown as a negative number for visual effect. The value of gold is based on the official holdings at that time multiplied by the current market price.) If you factor in GDP, the closeness of those numbers seems very odd.

The instability of the Exter Pyramid shows the relationship between the gold base and everything piled on top of it. The higher the ratio, the more upward pull there is on the value of the base, and the more downward pull there is on the value of the upper levels. After peaking out at 769.65 to one in July 2001, China's financial assets to gold reserves ratio has fallen to 353.34 to one in December 2011. America's ratio went up to 300 in the late 1990s, early 2000s before dropping down to 64.72 in December 2011. This would explain why gold has been in a bull market while stocks have been a bear market.

We can also look at cash to upper levels. China's ratio of financial assets to cash was 21.51 to one and America's was 25.59.

There is no correct ratio, we can only compare two or more economies and see which one is higher or lower. A higher number means eventually there will be an increase in value of the base (gold) and a decrease in the value of the upper levels (everything else). In this case, a re-adjustment (which is happening) will cause the revaluation of value to be highest in gold in China, then gold in the U.S., then cash in the U.S., and then cash in China. Since the price of gold is linked world-wide, that would mean a drastic change in the value of the rénmínbì. If the real value of each countries' stock markets and gold reserves were to not change, the CNY would have to devalue 90.01% to equilibrate. That would mean an exchange rate in the range of CNY 64.1386 to one U.S. dollar. If the Chinese stock market were to adjust to the same proportion of the Exter Pyramid as the U.S. stock market at the end of 2011, then the exchange rate value of the rénmínbì would have to be CNY 35.8691 to one U.S. dollar.

Although the Exter Pyramid is difficult to measure, we can easily compare basic asset classes across economies. There is no correct ratio, but if we compare the U.S. and China, we can see that China's basic pyramid is considerably more top-heavy than America's basic pyramid. The only way to bring them to equilibrium would be to drastically devalue the rénmínbì against the U.S. dollar.



P.S. from ZH

There is another explanation for what is going on that does not involved devaluating the CNY: it very well could be that just like in early 2009, China will any minute announce that it has built up a massive gold stockpile over the past 2 years which has gone on undisclosed.

Recall from April 2009 Reuters:

Shanghai/Beijing: China disclosed on Friday that it had secretly raised its gold reserves by three-quarters since 2003, increasing its holdings to 1,054 tonnes and confirming years of speculation it had been buying.


Hu Xiaolian, head of the State Administration of Foreign Exchange (SAFE), told Xinhua news agency in an interview that the country’s reserves had risen by 454 tonnes from 600 tonnes since 2003, when China last adjusted its state gold reserves figure.


The confirmation of its surreptitious stockpiling is likely to fuel market talk about Beijing’s ability to buy secretly and its ambitions for spending its nearly $2 trillion (around Rs100 trillion) pile of savings. And not just in gold: copper and other metals markets are booming thanks to China’s barely visible hand.


Speculation has gathered speed over the last year, since the tumbling dollar has threatened to weaken China’s buying power—and give it yet more reason to diversify into gold, oil and metals.