Quantitative easing revives gold’s reserve asset status

Once reawakened, central bank interest will not be quickly laid to rest

Gold lost its central role in the world monetary system on 15 August 1971, when US President Richard Nixon announced the ending of the gold exchange system: America would settle its deficits in dollars, not in bullion.

Half a century later, gold has crept back as a major force in world money. One important reason is quantitative easing. Central banks acquired large volumes of government bonds as a device to pour liquidity into markets shattered by catastrophic falls. But now that inflation has re-emerged much more strongly than anticipated, the bonds themselves have fallen significantly in value. This has exposed central banks to large balance sheet losses. This may not be an economic problem (because central banks can prosper despite having negative equity) but may cause them political headaches.

After Nixon’s action, individual countries were able in theory to exert national monetary sovereignty. In practice, however, market forces determined monetary policy and currency values. Gold was no longer the basis of the monetary system, yet its longevity as a basis of monetary circuit around the globe and through history made it still a desirable reserve asset. The market price of gold became perfectly ‘indexed’. It maintained its real value by adjusting its nominal value in line with inflation over the next 50 years.

Despite this built-in advantage, gold had one defect: it did not yield a nominal return. This was in contrast to government bonds, which, as international reserves soared in the past 30 years, became the preferred central bank reserve asset. Gold was for a time out of fashion. The exercise of 15 years of QE and the fraught budgetary position of many countries – not least of the main reserve currency nation, the US – has shown that bonds are not always a reliable reserve asset. Stagflation has forced a revision of central bank behaviour.

It is not only in the US where we see doubts about governments’ ability to maintain a credible level of budget deficit relative to gross domestic product. The UK experience in 2022 during the market turmoil over the economic experiments of Liz Truss, then prime minister, as well as the latest budgetary travails in Germany, have raised fresh doubts over governments’ financial capabilities. Rises in inflation have caused a collapse in the market values of the government bonds in central banks’ holdings. In contrast to gold, bond prices are inversely correlated to inflation. The preference for bonds relative to gold therefore lost an important part of its rationale.

Gold through the centuries

From a historical viewpoint, these fluctuations are nothing new. The fortunes of gold as a solid and respected basis for money has gone through a series of evolutions since Isaac Newton in his capacity as UK ‘master of the mint’ fixed the price of gold at £3, 17 shillings and 9 pence in 1717.

Gold was used as a basis of coins across the world over the centuries. But it was often devalued as impecunious kings reduced the amount of gold in coins without changing their nominal value. Newton fixed the gold content of the pound sterling with the British monarch renouncing the sovereign right to alter it.

Figure 1. The seven ages of gold

Above-ground gold stocks, tonnes, official gold holdings, tonnes and gold price, $ per ounce, 1835-2015

Source: World Gold Council, GFMS, OMFIF analysis

Note: This chart was created by OMFIF and used by the Financial Times in 2016, which is why the latest data are 2015.


The gold standard remained in place for most of the 18th and 19th centuries (Figure 1). This happy constancy was shattered in the early 20th century with the upheavals of the first world war and the interwar period of the 1920s and 1930s. The leadership of the global monetary system passed from Britain to the US. On becoming president in 1933, Franklin Roosevelt took America off the gold standard and raised the gold price from $20.67 per ounce to $35, where it stayed until Nixon’s action in 1971 inaugurated the dollar exchange standard.

The ending of the Newtonian gold standard marked the beginning of the age of democracy. Price stability was desirable, but only as one of the objectives besides full employment and economic growth. Mounting public expenditure from the 1950s onwards accompanied the rise of the welfare state, higher defence outlays on the Korean and Vietnam wars and the need for finance to fuel American businesses to buy industries abroad.

The post-1945 ballooning of the US trade and budget deficits laid the groundwork for a steadily increasing gold price. QE in the wake of the 2007-08 financial crisis has compounded the forces behind the transition. Central banks’ revived interest in gold has emerged into public view. Once reawakened, it will not be quickly laid to rest.

Meghnad Desai is Emeritus Professor of Economics at the London School of Economics and Political Science and Chair of the OMFIF Advisory Council. David Marsh is Chairman of OMFIF.

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