Despite the lackluster performance of Brazilian and Chinese stock markets this year, most of us – the aging dwellers of the decaying West – are still in the throes of the emerging markets’ “opportunity”. The relentless media pounding about the growth momentum among the Brics, the public awe at China’s new missiles, aircraft carriers and their “digested” technology of Japanese speed trains, the reverie caused by the seemingly boundless wealth of the Tatas, the Ambanis, the Deripaskas and the Slims – all generate countless metaphors of the changing pecking order on this planet. And the global statistics of capital flows support this increasingly common perception, showing a capital surplus of $0.5 trillion directed at the fertile grounds of EM.

Yet for each lucky winner who happened to hold his wealth on the Sri Lankan or Peruvian stock market this year, there are just as many stories of laggards and failures. Although the warning bells are ringing in most eagerly watched emerging markets (food prices in China, interest rates in Turkey, current account deficit in Brazil, high inflation in India unchecked even by a good monsoon), some peripheral countries are showing signs of advanced disease.

Nowhere is it more salient than in Vietnam. And what happens in Vietnam is of particular significance to any gold watcher. After all, Vietnam is the world leading per capita consumer of gold and imports the metal at a clip between 800tpa and 1000tpa. Vietnam’s gold investment demand powers on at 25% per year and in the third quarter it notched 45% of the volumes purchased by the more populous markets in India and China. What drives this gold fever in Vietnam? The short answer is – macroeconomic mismanagement.

Vietnam has had several chances to straighten its act. But the communist party’s eternal power struggle led to a stop-go approach to economic liberalization. Fifteen years after Vietnam closed its doors again to foreign investors (and then held it ajar), it is now plagued with a current account deficit, a 9% fiscal deficit, double-digit inflation, rising interest rates, mere $16bn in foreign reserves, a fragile banking system, SOE defaults and falling pledges from international donors.

In mid-2008, in an effort to narrow the trade deficit, the central bank tightened controls on gold imports. This led scarcity in the domestic market and opened a widening spread between domestic and international (or Thai) gold prices. Smugglers sought to capture an arbitrage opportunity by buying dollars to purchase gold abroad and bring into the country illegally. In response, Vietnamese consumers sold dong en masse to buy (dollar in order to purchase) gold with $26 premium over the global market price. This generated a strong demand for dollars with the widening gap between the official and unofficial exchange rates. Banks often need to pay a 20% premium for dollars and go to unofficial market to obtain the greenback, putting further pressure on the dong exchange rate and forcing devaluations whenever dong falls through the 3% to 5% managed float range.

Some of the gold import restrictions were lifted when the dong was devalued and in October 2010 the central bank announced it would consider granting permits (timed quotas) for gold imports if prices in the domestic market rose “unreasonably high”. Traders in South East Asia claim that re-opening of the officially sanctioned channels has historically proven to be a price-supportive signal for the physical market in the region.

However, by now the vicious circle has been established. Typically, the authorities’ first reaction to tackle the gold import pressure is by expanding the quotas for several additional tonnes. Should the global gold prices continue to rise and the price-taking importing country continue to hemorrhage foreign exchange, the next step is devaluation (which occurred three times between November 2009 and November 2010) and an inflation-stemming interest rate rise. The former increases further the attractiveness of gold as an alternative currency and an inflation hedge.

The weak currency and entrenched inflation mean that few people are willing to use the dong to make payments. This is particularly true for term payments, not just daily staples. Common to the bubbly conditions in some other Asian cities, apartment prices in Ho Chi Minh City grow by 30-40% year on year. Gold (rather than dollars) is used to purchase big ticket items such as real estate and gold shops double up with the function as foreign exchange counters. The ban on gold exchanges in March this year has led to anarchic gold market conditions, with a palliative of an “official gold exchange” now sought by one state-owned bank.

As of January 1st, Vietnam is imposing yet another slew of administrative curbs on gold, this time in the form of 10% export tax. This could be little more than an attempt to capture more revenue (Vietnam exports nearly $3bn worth of precious metals annually), but will be of no help if the prices stabilize.

Capricious policymaking and administrative unpredictability are at the root of gold’s dubious “success” in the context of the Vietnamese morass. This could be the most important lesson yet for those Washington and European politicians whose populist agendas aim at undermining of central banks’ independence.

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Tags: exchange rates and gold, Vietnam gold demand, Vietnam gold imports, Vietnam macroeconomic mismanagement and gold