Bullion Bulletin: Central Banks and Gold

Last year, the collective total gold holding by central banks was the highest in more than 30 years, around 36,000 tonnes according to the World Gold Council (WGC). Why do central banks own gold?

It’s partly a matter of history – holding gold was long a habit for central banks because of its status as money – and partly sound economic policy. Gold has proved itself a useful diversifier (and thus can help in providing stability), as it has an inverse relationship with the US Dollar – when one dips in value, the other usually rises.

Gold vies with the US Dollar for ‘safe haven’ status – in times of economic fragility both are regarded as providing some protection, for different reasons. Gold partly because it carries no counter-party risks, it is no-one’s liability, and more supply cannot be created. The US Dollar because it’s the world’s reserve currency and used for the majority of international transactions, and has the backing of the world’s economic superpower.

The value of the US Dollar against gold has however dropped sharply over the last decade, thanks to low interest rates and cheap money, which in turn follow an increase in the US currency supply, used to bail-out the bankrupt and subsidise those forced to stay at home during the pandemic. The ripples from the 2008 financial crisis, when trust in the Dollar faltered, are still lapping at economies today; so too are the 2020-21 pandemic waves.

Essentially a central bank is in charge of the conduct of monetary policy, aiming to achieve price stability – i.e. ensuring low and stable inflation. A central banker is obsessed with risk, and how to reduce it. Protecting a national currency from becoming devalued and managing economic fluctuations are two main responsibilities of a central bank. Since the late 1980s targeting inflation has become the leading framework for monetary policy.

It might be said that they’re not doing a great job at the moment: inflation in the Eurozone (with the European Central Bank, ECB, in charge) reached another high, of 8.1%, in May; in the UK (where the Bank of England, BoE, runs the shop) consumer prices rose 9% in annual terms in April; in the US, the annual rate of inflation in April was 8.3%, marginally down compared to March, but the consumer price food index rose by 9.4%, the biggest 12 month increase since April 1981.

The US has the most gold, more than 8,100 tonnes, which is almost 78% of its total foreign reserves. Some central banks of leading economies have sold some or all of their gold – the Banque de France sold 588 tonnes during 2004-08; the Swiss National Bank sold 1,550 tonnes during 2000-08.

Germany has the second biggest gold holdings, after the US. For Jens Weidmann, president of Germany’s central bank (the Bundesbank) from 2011 until the end of 2021, “anyone in Germany… will say that [gold] is synonymous with enduring value and economic prosperity”.

The US Dollar however has lost almost 90% of its value since 1970, thanks to an inflation rate averaging almost 4% a year, which has produced a cumulative price increase of more than 645%. Prices in Dollar terms are 7.45 times higher than average prices in 1970; a Dollar today buys around 13% of what it could get in 1970.

A long-term and for many an imperceptible decline in the Dollar’s value is perhaps one reason why some countries have decided to diversify from the Dollar, and are often choosing to hold more of their reserves in gold.

The freezing of internationally-held assets belonging to Russia – the ‘weaponisation’ of the Dollar – will only further discourage nations from relying on the US fiat currency. By sanctioning Russia in such a fashion the US Dollar has damaged its status as a reliable asset in tough times. Russia has in any case increased its gold holding from 883 tonnes at the end of 2011 to more than 2,300 tonnes today; Turkey has acquired 278.55 tonnes since 2017; India’s gold reserves have swelled from more than 557 tonnes at the end of 2016 to more than 754 tonnes at the end of 2021. Brazil, Hungary and Thailand all bought gold last year.

Fun fact, to help you to picture how much gold these countries hold; a tonne of gold is about the same weight as a Fiat 500 car, or a baby Blue whale.