One of the most significant changes in the world of money has been happening by stealth rather than through any policy announcement. Gold has regained a solid yet unofficial role in the world’s monetary system in a barely noticed, gradual process that cannot now be overlooked.
This is the result of several interlinked reasons. The last few years have seen central banks run into gold, accelerated by declining trust in the dollar following western countries’ freezing of $300bn of Russian foreign exchange reserves after the Ukrainian invasion.
The sharp rise in interest rates since the end of 2021 has led to significant losses for worldwide bondholders. This applies not just to commercial banks and asset managers but also, crucially, to many internationally operating central banks that acquired large stocks of government bonds in successive rounds of quantitative easing. This has damaged the validity of government bonds as a core element of central banks’ reserves.
This has had a significant side effect. Gold-holding central banks in Europe seem likely to resort (either formally or informally) to using their gold revaluation accounts to plug balance sheet losses to be unveiled in coming years. They find this a more palatable option than the alternative – asking their governments to recapitalise them during a budget squeeze.
Recapitalisation would undermine central banking independence by exposing the need for bail-out measures. However, the option they seem most likely to choose could have uncomfortable effects. By demonstrating the new-found monetary importance of gold, which has been slumbering unused in their reserves for decades, central banks could endanger confidence in the national currencies they issue and guarantee. They could provoke further moves out of fiduciary currencies and into gold by emerging market central banks seeking to emulate their more established European counterparts.
The fight against inflation
In their latest anti-inflation assault, central banks worldwide have raised interest rates by the fastest in decades, comprehensively breaking the bull market. Since 2020, 30-year US treasuries have declined by over 50% in value, while shorter-term treasuries have lost between 10% and 15% on average. Banks’ balance sheets have been hammered, and five US banks collapsed in 2023 – the most in seven years. Total unrealised losses on commercial banks’ bond holdings have already reached $650bn.
Central banks face unprecedented losses on their bond holdings as well. Since the 2008 financial crisis, they have accumulated $21tn of assets during a decade-long wave of market support though QE. As a result of efforts to lower balance states, including through quantitative tightening, this number is currently down to $16tn. In the last 15 years, the balance sheets of the Federal Reserve, European Central Bank and Bank of Japan have risen by $6.5tn, $5.8tn and $3.6tn, respectively.
Partly as a reaction to QE-induced currency debasement, many countries, primarily east of Germany, started accumulating gold in the last decade. The rise in the People’s Bank of China’s gold reserves is particularly noteworthy since it has coincided with a sharp fall in officially reported Chinese holdings of US Treasury securities (Figure 1).
Figure 1. China’s gold reserves versus holdings of US treasuries
$bn (LHS), tonnes (RHS)
Source: US Treasury, International Monetary Fund
According to US Treasury statistics on China’s official depositary holdings (which undoubtedly understate the level of China’s overall Treasury investments), China stopped adding to its treasuries in 2014, after the first US sanctions on Russia were imposed in reaction to the takeover of the Crimea. China has prioritised alternative instruments in recent years and now owns less than $780bn in Treasury holdings. This is down 40% from nine years ago, though these figures do not include dollar investments made via European depositories.
Russia has been much more aggressive and sold all its Treasury securities in the last 15 years. The $300bn asset freeze confirmed President Vladimir Putin’s belief that gold was a safer reserve asset.
Gold rush
The extension of western sanctions across the financial system, which some have termed ‘dollar weaponisation’, has given many large emerging market economies an incentive to divert foreign holdings into gold. This is seen (depending on the places where it is stored) as less susceptible to confiscation. Brazil, Russia, India, China and South Africa have bought almost 5,000 tonnes of gold for their official reserves in the last 15 years. China and Russia both added more than 1,500 tonnes, while India has added around 450 tonnes (Figure 2).
Figure 2. Gold holdings in tonnes, 2000-22
Source WGC, latest data available are 2022
Even some European Union countries joined the gold rush. Poland more than tripled its gold holdings to 333.7 tonnes in 2023 from 102.8 tonnes in 2000. After Czech National Bank Governor Aleš Michl declared he would like to increase the bank’s gold reserves by approximately ‘tenfold’, the bank’s gold holdings have increased by 37.5% since January. The Hungarian central bank had similar ambitions, increasing its gold reserves to 94.5 tonnes in 2021, from just 3 tonnes in 2018.
2022 saw the highest central bank gold purchases since 1968. The US, Germany, and France have gold reserves surpassing the 50% level of all financial reserves, but have not increased their physical gold holdings in recent years (Figure 3).
Figure 3. The percentage of overall reserves now held in gold
$bn
Source: World Gold Council, latest data available are 2022
After bottoming out around 1999, the gold price has increased by almost 10% on average per year. This revaluation of gold brings some advantages for central banks. De Nederlandsche Bank President Klaas Knot remarked in a November 2022 interview that the current gold revaluation accounts can be used to restore central bank balance sheets: ‘The balance sheet of the Dutch central banks is solid because we also have gold reserves and the gold revaluation account is more than €20bn, which we may not count as capital, but it is there.’
Earlier this year, Bundesbank executive board member Joachim Wuermeling agreed gold revaluation accounts could be used to cover losses on the balance sheet: ‘The most important revaluation item is the reserve for 3,355 tonnes of gold. In fact, the value is about €180bn above the cost of purchasing it, so this is a reserve for us… The balance sheet of Deutsche Bundesbank is on firm ground, and this certainly makes it easier for us to bear losses over a certain period.’
For technical and accounting reasons, central banks are more likely to turn to the GRAs as a psychological cushion, rather than use them formally to reinforce their capital. There is an opportunity for the US as it still values gold at its historical cost price of $42.22 per ounce. The gold reserve held by the Treasury is partially offset by a liability for gold certificates issued to the regional Feds at the statutory rate, which the Treasury may redeem at any time. This means that 8,000 tonnes of gold is used for both balance sheets.
International market participants as well as central bankers around the world will be watching whether – perhaps after the presidential election in less than 12 months – the US will move towards any explicit or implicit gold revaluation. That would mark a further step in gold’s long journey back towards the centre of the monetary stage.
Willem Middelkoop is the author of The Big Reset, a member of the OMFIF Advisory Board and founder of the Dutch-based Commodity Discovery Fund.