Global central bank gold holdings: background, trends and implications

Source: "China Foreign Exchange"

Author | Cheng Shi, Chief Economist of ICBC International

Xiaomeng Wu, China Institute of Economics and Management, Central University of Finance and Economics

main point

Emerging market central banks will continue to increase their gold holdings in the foreseeable future, but the magnitude will return to the normal trend from the ultra-high level in 2022. This move will reduce the dependence of the international financial system on the US dollar and help accelerate the change of the global monetary landscape.

Since 2022, driven by geopolitical risks and global economic stagflation, central banks dominated by emerging market economies have increased their gold reserves significantly. The following is an analysis of the background and characteristics of this round of central bank gold holdings, and forecasts for future development trends and impacts.

The background to the recent increase in global central banks' gold reserves

In the current complex international political and economic context, this round of global central banks' massive increase in gold holdings is the result of a combination of long-term, medium-term, and short-term factors, and is driven by both active allocation and passive adjustment.

From a long-term perspective, the instability of the current international monetary system and the growth of foreign exchange reserves in emerging market economies have provided impetus for central banks to increase their holdings of gold. On the one hand, some major central banks, especially those in emerging market economies, have been seeking to de-dollarize their foreign exchange reserves and reduce their over-reliance on the US dollar. Under the current international monetary system, the US dollar, as a means of payment for global consumption and debt, is one of the main tools for the US to capture the development results of emerging market economies. At the same time, the international monetary system dominated by a single dollar also lurks huge risks, especially after emerging market economies generally joined the last round of globalization, the US domestic crisis was transmitted to the world through the US dollar, causing a huge impact on global financial stability. After several global financial crises, most major emerging market economies began to actively seek to diversify their reserves. On the other hand, with the development of emerging market economies, the scale of their foreign exchange reserves is on the rise as a whole. Driven by the demand for reserve diversification, gold has become one of the main allocation directions of incremental reserves. For example, the Russian central bank has been buying gold for more than a decade, and the Indian central bank has also continued to buy in the past five years.

From a medium-term perspective, the value preservation and safe-haven properties of gold are favored by global central banks. On the one hand, the solidification of the global stagflation pattern has attracted much attention to the value preservation properties of gold. Gold has been widely used as a general equivalent for a long time in human history, and its stable supply is one of the important reasons. For example, in the past ten years, the global gold supply has basically remained around 4,600 tons, with annual fluctuations of no more than 300 tons; the annual supply accounts for only about 2% of the total gold in the table, and there is basically no possibility of artificial manipulation to increase production significantly in the short term. From 1974 to 2022, the average annual growth rate of the basic money supply in the United States has reached about 10%. In contrast, gold has outstanding advantages in terms of value preservation. The current low global growth situation is difficult to reverse in the short term. Inflation caused by supply shocks remains high under the influence of deepening anti-globalization, and the stagflation pattern begins to solidify in the medium term. In the context of the overall decline in the potential returns of risk assets, although gold does not directly generate interest, the relative returns brought by its value preservation properties are revealed. On the other hand, the rise of geopolitical risks has made gold's safe-haven properties prominent. Gold's application in industrial production is relatively limited, and it has little correlation with economic fluctuations. In addition, gold has no obvious correlation with the underlying assets measured by any currency. Therefore, when a geopolitical conflict breaks out, whether the impact is local or global, it basically does not affect the safe-haven properties of gold, which makes it more reliable than other safe-haven assets such as the yen and the Swiss franc. For the above two reasons, the evolution of the international political economy in the medium term has formed the main driving force for central banks to actively increase their holdings of gold.

From a short-term background, the sharp fluctuations in the global market in the past year have also forced central banks to increase their allocation of gold to cope with risks. On the one hand, the Federal Reserve's aggressive interest rate hikes have led to the deterioration of the global central bank's US bond position, and gold has become the main alternative asset. In March 2022, the United States began its first interest rate hike since 2018, and quickly raised the single interest rate to 75 basis points, and quickly raised the rate of interest rate to 450 basis points in just 11 months, which is rare in history. The yield of US Treasury bonds rose rapidly. The yield of 1-year Treasury bonds rose from nearly 0% to 5%, and the price of US bonds fell sharply accordingly. The central banks of emerging market economies generally hold a large amount of US bonds, and in order to avoid the deterioration of their balance sheets, they have quickly reduced However, due to the universality of global interest rate hikes, switching to other developed economy government bonds poses the same risk, and the currency value is not as strong as the US dollar; emerging market government bonds also have high exchange rate risk and insufficient market depth. Therefore, gold has become one of the few alternative assets after the central bank sells US bonds at this stage. On the other hand, the risk appetite of international capital markets will drop sharply in 2022, and the narrowing or even inversion of interest rate differentials between emerging markets and developed markets will also make global liquidity flow back to developed markets, which also forces emerging market economies to increase their holdings of gold to cope with the huge pressure of local currency depreciation.

The characteristics of global central banks' recent increase in gold reserves

In recent years, due to geopolitical uncertainties and the trend of anti-globalization, the number of global central bank gold reserves has generally shown an upward trend. According to the World Gold Council, the annual gold purchase demand of global central banks reached 1,136 tons in 2022, an increase of 152% from 450 tons in 2021 and a new high since 1950. Among them, the net purchase of central banks in the fourth quarter was 417 tons, which drove a significant increase in the total annual holdings (see attached picture).

Net changes in the total size of global central bank gold reserves over the years (unit: tons)

Data Source: World Gold Council

In terms of regional distribution, gold purchase demand mainly comes from the central banks of emerging market economies, including China, Turkey, India, etc. China has purchased a total of 1,448 tons of gold from 2002 to 2019. China resumed its purchases in 2022. In November and December, the People's Bank of China announced that the total amount of gold purchased reached 62 tons, and the total amount of gold reserves exceeded 2,000 tons for the first time. Turkey's central bank reported that gold reserves increased by 148 tons in 2022 to 542 tons. Although India continued to buy gold in 2022, the increase decreased to 33 tons, a decrease of 57% from the purchase of 77 tons in 2021. This is mainly due to the country's purchase of gold in 2022foreign exchange marketThe move to support the rupee has reduced foreign exchange reserves by $70 billion, affecting gold purchases. As of the end of 2022, India's gold reserves stood at 787 tons.

In other emerging market economies, the Middle East was the leading gold buyer in 2022, with Egypt (47 tonnes), Qatar (35 tonnes), Iraq (34 tonnes), the United Arab Emirates (25 tonnes) and Oman (2 tonnes) all adding significantly to their gold reserves. Gold reserves are also growing in Central Asia, with Uzbekistan, a net seller at the start of the year, but eventually a net buyer, adding 34 tonnes to its gold reserves. A special case is Russia, where the central bank has been a net buyer of gold since the 2006 calendar year and the largest buyer of gold in the international market over the past decade, but sold around 3 tonnes of gold in 2022.

From a structural perspective, there are significant differences in the proportion of central banks' gold to foreign exchange reserves in different countries or regions. 59% of countries or regions worldwide have gold reserves accounting for less than 10% of foreign exchange reserves, 15% of regions have a proportion of 10% to 20%, 13% of regions have a proportion of 20% to 50%, and only 12% of countries or regions have a proportion of more than 50%. In particular, the United States and Germany, the proportion of gold in foreign exchange reserves is as high as 67.1% and 66.5% respectively, much higher than that of other countries or regions.

The comparison between the current round of central bank holdings of gold reserves and the historical situation

Global central bank gold reserves have shown a trend of first falling and then rising since 2000. From 2000 to 2009, global gold reserves fell from 28,960.76 tons to 25,823.30 tons, a decrease of 10.8%. From 2009 to 2022, global gold reserves rose from a low to 31,567.69 tons, an increase of 22.2%. The turning point in the trend of global gold reserves mainly occurred in the international financial crisis in 2008. From 2000 to 2008 was the golden age of globalization. Developing countries exported goods and labor to developed countries for official reserve assets. Before 2008, due to the optimistic economic growth prospects, the liquidity environment of credit money was not yet flooded, and part of the increase in supply was carried out by using gold reserves. After 2008, the world entered an era of low growth, low inflation, and low interest rates. While developed countries paid developing countries through credit currencies such as the US dollar, they also issued a large number of currencies, causing the depreciation of foreign exchange reserves in developing countries. This led developing countries to take the initiative to reduce the depreciation risk of concentrated foreign exchange reserves and began to increase their efforts to increase other reserve assets such as gold and special drawing rights.

From 2000 to 2009, the five countries with the largest reductions in gold reserves were Switzerland, France, the Netherlands, the United Kingdom and Spain, which reduced their holdings by 1550.08 tons, 571.86 tons, 299.37 tons, 278.02 tons and 241.86 tons respectively, accounting for 93.6% of the total reduction in gold reserves during this period. At this stage, developing countries increased their holdings of gold reserves against the trend. Saudi Arabia and Russia increased their holdings by 179.95 tons and 109.27 tons respectively during this stage.

From 2009 to 2022, the five countries with the largest increases in gold reserves were Russia, China, India, Turkey and Kazakhstan, which increased their holdings by 1766.66 tons, 1410.53 tons, 429.65 tons, 425.70 tons and 279.70 tons respectively, accounting for 74.1% of the total increase in gold reserves in this stage. The rest of the increase in gold reserves also came mainly from many developing countries. The reduction in gold reserves in this stage was mainly from Venezuela, Germany, Libya and France, which reduced their holdings by 195.22 tons, 57.44 tons, 27.18 tons and 16.02 tons respectively.

Looking at the longer historical cycle, the trend of global central bank gold reserves is closely related to the development of the economy and related policies. The period of the 1960s and 1970s was the historical peak of central bank gold reserves. At that time, many countries adopted policies to control the economy, and the international monetary system was also undergoing changes. Central banks increased their gold reserves, on the one hand to ensure the stability of the national economy, and on the other hand to cope with changes in the international monetary system. The global economy underwent a transformation during the period from the 1980s to the early 2000s. Many countries began to give up economic regulation and adopt policies of free market economy. At the same time, with the development of financial innovation, many new financial instruments gradually became popular, and these factors led to the gradual decline of central bank gold reserves. In recent years, due to factors such as geopolitical risks and economic instability, gold reserves have once again gained popularity among central banks.

Changes in historical reserves of the top ten countries with global central bank gold reserves (unit: tons)

Data sources: World Gold Council, central banks

Looking at the historical changes in the gold reserves of China and the United States, the United States has continued to increase its gold reserves since the Gold Purchase Act of 1934. By the 1960s, its gold reserves reached about 20,000 tons, accounting for nearly 80% of the global gold reserves. Then, with the collapse of the Bretton Woods Agreement on the peg of the dollar to gold, coupled with the intensification of economic recession and inflation in the early 1970s, the US fiscal and monetary policy became tight, and the US central bank gradually reduced its gold reserves. Since 2007, the US gold reserves have remained stable. At 8,133.5 tons by the end of 2022, it still ranks first in the world, accounting for 67.1% of its total foreign exchange reserves. The People's Bank of China has carried out five major rounds of gold reserve increases since 2000, reflecting the gradual development of gold as an important investment and risk management tool under the policy of diversifying foreign exchange reserves.

Future gold prices and central bank gold reserves

After the disintegration of the Bretton Woods system, although gold was replaced by the US dollar and basically withdrew from the category of general equivalents, the price of gold is still mainly dominated by the liquidity of the US dollar, and its financial attributes exceed its commodity attributes. Since the fourth quarter of 2022, with the continuous decline in commodity inflation, the year-on-year growth of the US consumer price index (CPI) and core CPI has also formed a downward trend. The US unquarterly CPI rose by 6.4% year-on-year in January 2023, continuing to be lower than the previous value of 6.5%, and the year-on-year growth rate declined for seven consecutive months; the unquarterly core CPI recorded an annual rate of 5.6% in January, the smallest increase since December 2021. The continued easing of inflationary pressures has led the Federal Reserve to move from the rate hike up the ante stage to the rate hike reduction stage, and it is expected to maintain a minimum rate hike of 25 basis points each time until the end of the rate hike. The dollar index has fallen by about 9% since reaching a phased peak of 114.16 at the end of September 2022. The weakening of the dollar index will be conducive to the upward movement of gold prices.

With the further advance of interest rate hikes, the risk of recession in the United States and Europe will also increase. Under the foreseeable risk of recession in the future, major central banks around the world may start to consider stopping the process of interest rate hikes. From the perspective of historical trends, there is a negative trend correlation between the price of gold and the target interest rate of the Federal Reserve. Therefore, when the US dollar's interest rate hike cycle peaks, and then a new round of interest rate cuts due to recession, gold may be able to start a new round of upward trend. In addition, in the current lack of long-term momentum for global economic growth, the widening gap between the rich and the poor caused by monetary effects, coupled with the increase in geopolitical risks, has increased the probability of financial marekt risk events. Gold's safe-haven properties also make it more attractive than other asset classes.

In contrast, the impact of the physical supply and demand of gold on the trend of gold prices is not obvious. From the perspective of the supply and demand situation after 2010, the supply and demand of gold basically maintained a small surplus (supply exceeds demand), and only the supply and demand deficit appeared between 2011 and 2013, but the gold price showed an overall upward trend in this stage. After 2008, the shadow of the world falling into recession again always lingered. The stimulus policies of major central banks around the world were difficult to change the lack of global demand. The reality of long-term low growth and low inflation made gold at this stage, even if the physical supply and demand surplus has been basically maintained, the overall trend is still upward. In 2022, with the increase in the demand for gold purchased by central banks, the gold supply and demand surplus will be greatly reduced, and the supply and demand will be basically balanced. If the central bank continues to increase its purchases, it may form a deficit between supply and demand in the future. Therefore, fundamental supply and demand also support the upward trend of gold prices to a certain extent.

Combining optimistic price expectations, the central bank's hedging and decentralized allocation of dual demand, and the current low proportion of gold reserves in emerging markets, the author believes that the central banks of emerging market economies will still increase their holdings of gold in the foreseeable future, but the magnitude will return to the normal trend from the ultra-high level in 2022. In the developed economies of Europe, America, there is no clear motivation to increase or reduce their holdings of gold, and it is expected that the central bank's reserves will be roughly flat.

Analysis of the impact of global central banks' increased holdings of gold reserves

The increase in gold holdings by global central banks will undoubtedly have a profound impact on the international monetary and even financial system, mainly reflected in three aspects.

First, the increase in central bank gold reserves will reduce the dependence of the international financial system on the US dollar, which is conducive to accelerating the change of the global monetary pattern. As global overcapacity and insufficient demand become a long-term reality, the marginal effect of stimulating demand through dollar liquidity is decreasing, but the frequency and depth of global crises caused by the dollar liquidity cycle are at risk of increasing. At the same time, the United States has frequently imposed financial sanctions on Iran, North Korea, Russia and other countries through dollar hegemony in recent years, which also shows the injustice of the dollar standard system. Overall, the shortcomings of the international monetary pattern dominated by the single dollar have become more and more prominent, and the risk and return of emerging market economies participating in the single dollar system have decreased significantly. Although there is no single currency that can replace the hegemony of the US dollar, emerging market economies have invariably replaced the US dollar with super-sovereign gold, essentially casting a vote of no confidence in the dollar standard. The continued evolution of this trend will accelerate the change of the global monetary landscape and promote the formation of a more stable, fair and sustainable monetary system.

Second, the increase in central bank gold reserves will help emerging market economies enhance their monetary credit and increase their monetary policy independence. To promote the reform of the global monetary system, emerging market economies need to have the voice over themselves and be able to participate in the process of system change and rule-making. This also includes objective requirements for improving international credit, enhancing currency stability and convertibility of emerging market currencies. Currencies with more gold reserves can significantly improve currency credit, reduce the risk of sharp depreciation, and effectively deal with the risk of imported inflation, thereby enhancing the independence of emerging market economies' monetary policies to a certain extent.

Third, the increase in the central bank's gold reserves helps to provide credit endorsement for the central bank's digital currency, which is conducive to the development of digital currency. At present, many central banks, including China, are vigorously developing digital currency, in order to take the lead in the evolution of the international financial system driven by new technologies. Although the central bank's digital currency has the advantages of low issuance and management costs, high transparency, and stable supply, and is also expected to solve the liquidity and regulatory blind spots that have plagued the development of digital currency, due to its technical barriers and the sovereignty of the issuer, it is objectively necessary to have a super-sovereign store of value and measurement tools for endorsement in the early stage of development to reduce the difficulty of its international marketing activities. The increase in the central bank's gold reserves can precisely provide potential credit support for the issuance of its digital currency. In recent years, the price correlation between gold and digital currencies has reflected the compatibility of the two to a certain extent. Looking to the future, the integration of central bank gold and digital currencies is highly imaginable and may provide a key boost for the development of digital currencies.