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Central Banks Buy Gold as Dollar Hedge

June 26th, 2017 by

It’s been nearly five decades since the Bretton Woods system, a de facto gold standard, was abandoned by the Nixon administration in 1971. Under this arrangement, the price of gold was fixed to a specific dollar amount (generally $35 per ounce), and then all other world currencies were tied to the dollar. The U.S. Treasury Department freely bought and sold gold at close to this benchmark price, though no private gold market was permitted to exist.

balance of gold and dollar

However, as the economies of Europe and Asia grew after WWII, the amount of dollar assets in the world far exceeded the set exchange value of the U.S. gold stockpile. Any “run on the bank” by international investors would cause the system to collapse. This is why President Nixon decided to “close the gold window,” ending the redemption of gold for dollars by the government.

Gold as an Asset

This decoupling of the U.S. dollar from gold does not mean that central banks simply abandoned gold ownership (although these institutions would probably like you to believe that).

In fact, according to the Financial Times, gold stores by central banks have actually reached an 18-year high. Central banks currently hold over 31,000 metric tonnes of gold collectively. This is 50% more than the approximately 20,000 tonnes of gold held by the U.S. Treasury following World War II, which is widely considered the single largest gold stockpile ever amassed in human history.

The rise in central bank gold stockpiles is, for all intents and purposes, a hedge against the dollar. As central banks around the world have vastly increased their dollar assets over the last half-century, they are now buying gold as a form of insurance against a weaker dollar in the future.  (Regarding the strength of the dollar, even former U.S. Treasury Secretary Larry Summers has said that the Fed lacks credibility.) By hedging against the possible waning of the dollar’s supremacy through balance-sheet exposure to gold, these banks are taking a page straight out of China’s monetary policy playbook.

According to the Official Monetary and Financial Forum (OMFIF), the usual suspects were the largest accumulators of gold: Russia, China, and Kazakhstan—a country that may boast the most productive state-run gold mine in the world.

This makes sense given the current environment for state treasuries and financial firms: above all else, uncertainty reigns supreme. Consequently, these central banks are hungry for tangible assets that generate a return rather than relying solely on securities that seem riskier by the day. By comparison, gold is regarded as a stable store of wealth—as evidenced by the fact that even central banks are stocking up on it!

 

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.

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