Why Are World’s Major Banks Buying Gold At A Rapid Pace And What Does This Mean For The Dollar? – OpEd

Gold is one of the oldest and most trusted forms of money in human history. It has been used as a store of value, a medium of exchange and a unit of account for thousands of years. Gold is also considered as a safe haven asset that can protect investors from inflation, currency devaluation and geopolitical risks. 

In recent years, gold has attracted the attention of central banks around the world, which have been buying gold at a record pace. According to the World Gold Council (WGC), central banks globally have accumulated gold reserves this year at a pace never seen since 1967, when the US dollar was still backed by the precious metal. In the quarter ending September 2022, demand for gold was up 28% year-on-year, reaching 1,181 tons. A significant chunk of this demand came from central banks in recent months, setting a record of nearly 400 tons that lifted central bank net purchases to date to 673 tons. 

But why are central banks buying so much gold? What are their motivations and objectives? And what are the implications for the global monetary system and the US dollar? 

Diversification and hedging

One of the main reasons why central banks are buying gold is to diversify their foreign exchange reserves and hedge against currency risks. Most central banks hold a large portion of their reserves in US dollars, which is the dominant reserve currency in the world. However, holding too many dollars exposes them to the fluctuations of the US economy and monetary policy, as well as the potential devaluation of the dollar due to inflation or political uncertainty. 

Gold, on the other hand, is seen as a more stable and independent asset that can preserve its purchasing power over time. Gold is also less correlated with other assets and currencies, which means it can reduce the volatility and risk of a central bank’s portfolio. Moreover, gold can act as a hedge against negative interest rates, which have become more prevalent in some developed economies in recent years. 

Some of the major gold buyers in recent quarters include Turkey, Uzbekistan, India, China and Russia. These countries have different economic and geopolitical situations, but they share some common factors that may explain their appetite for gold. For instance, Turkey has been facing high inflation, currency depreciation and political instability for several years, which have eroded its confidence in the dollar and other fiat currencies. Uzbekistan has been undergoing a transition from a centrally planned economy to a market-based one, which requires it to diversify its sources of income and wealth. India has a strong cultural affinity for gold and a large current account deficit that makes it vulnerable to external shocks. China and Russia have been pursuing strategic goals of reducing their dependence on the dollar and challenging its dominance in global trade and finance. 

Confidence and credibility

Another reason why central banks are buying gold is to enhance their confidence and credibility in the eyes of their domestic and international audiences. Gold is widely regarded as a symbol of wealth, power and sovereignty. By increasing their gold holdings, central banks can signal their strength and stability to their citizens, markets and peers. 

Gold can also help central banks to maintain or increase their influence in regional and global affairs. For example, China and Russia have been advocating for a multipolar world order that challenges the US-led hegemony. By accumulating gold reserves, they can support their own currencies and alternative payment systems that bypass the dollar-dominated SWIFT network. They can also increase their voting power in international institutions such as the International Monetary Fund (IMF), where gold is part of the quota formula. 

Furthermore, gold can help central banks to prepare for potential crises or conflicts that may disrupt the normal functioning of the global financial system. In such scenarios, gold can provide liquidity, security and flexibility to central banks that may face difficulties in accessing or using other reserve assets. Gold can also serve as a last resort asset that can be used to settle debts or obligations among countries. 

Threat to the dollar?

The increasing demand for gold by central banks raises some questions about the future role of the dollar as the world’s reserve currency. Does this mean that central banks are losing faith in the dollar? Are they trying to undermine its status and value? And how will this affect the US economy and its global leadership? 

The answer is not so simple or straightforward. While it is true that some central banks may have political or strategic motives to reduce their reliance on or challenge the dollar, it does not necessarily mean that they are abandoning it altogether or replacing it with gold. The dollar still has many advantages that make it attractive and indispensable for global trade, finance and investment. These include its liquidity, depth, stability, acceptability and legal framework. 

Moreover, gold is not a perfect substitute for the dollar or any other fiat currency. Gold has some limitations that limit its use and functionality as money. For example, gold is scarce, costly to store and transport, difficult to verify and divide, subject to price volatility and manipulation, and lacks a clear regulatory framework. 

Therefore, it is unlikely that central banks are buying gold with the intention or expectation of replacing the dollar with gold as the global reserve currency. Rather, they are buying gold as a complement or supplement to their existing reserve assets, especially in times of uncertainty or instability. Gold can provide them with some benefits that other assets cannot offer, such as diversification, hedging, confidence and credibility. 

However, this does not mean that the dollar is immune or invincible to any challenge or threat from gold or other currencies. The dollar’s dominance depends on many factors that may change over time, such as economic performance, monetary policy, fiscal discipline, political stability, technological innovation and international cooperation. If these factors deteriorate or fail to meet the expectations of global investors and users, then the demand for and value of the dollar may decline relative to other assets or currencies. 

In conclusion, 

• Central banks are buying gold at a record pace for various reasons such as diversification, hedging, confidence and credibility. 

• Central banks are not buying gold to replace the dollar as the global reserve currency, but rather to complement or supplement their existing reserve assets. 

• The dollar still has many advantages that make it attractive and indispensable for global trade, finance and investment, but it also faces some challenges and threats from gold and other currencies that may affect its demand and value in the future.