Best Of 2011: Central Banks — The Hidden Gold Demand Grows

December 27, 2011





Where did all this gold come from?

Ultimately, it goes back to Franklin Delano Roosevelt in 1933, who criminalized the holding of gold by U.S. citizens (seriously). FDR engaged in some massive sleight of hand, buying gold en masse from the citizens of the country at roughly $20 an ounce, and then pegging the dollar to an ounce of gold at $35. After World War II, the Bretton Woods agreement and the foundation of the International Monetary Fund further entrenched central bank ownership of gold as the foundation, effectively, for the world’s currency system.

And while you’d be hard-pressed to find a central banker who’d admit to it, gold still serves as a reserve asset. Ownership of an asset that’s rising in value in its own currency gives a central bank options, more than anything else, because it self-protects against inflation. On the other hand, central banks like to buy low and sell high too.

So who’s buying now, with gold at all-time highs? The short answer is “we don’t really know.” What we do know is that the signatories to the current CBGA were not big sellers of gold (as the above charts show), and it’s unlikely, given the state of the eurozone, that they were big buyers either. Instead, the smart money is on China and Latin American countries fueling the central bank buying.

Increasing their gold reserves, particularly for China, acts as a kind of ballast that further reduces their dependence on the U.S. dollar. With China seeking to make the renminbi a reserve currency, a deep gold reserve is almost a necessity. And a high price of gold makes the U.S. seem like less of a reserve currency, and anything more tightly tied to gold, more of one.

This was all famously the subject of a diplomatic cable (exposed by WikiLeaks) back in 2009, when many suspect China began its slow accumulation of gold reserves. While conspiracy theorists went nuts, there’s much to consider in the content of the cable:

“The U.S. and Europe have always suppressed the rising price of gold. They intend to weaken gold's function as an international reserve currency. They don't want to see other countries turning to gold reserves instead of the U.S. dollar or euro. Therefore, suppressing the price of gold is very beneficial for the U.S. in maintaining the U.S. dollar's role as the international reserve currency. China's increased gold reserves will thus act as a model and lead other countries towards reserving more gold. Large gold reserves are also beneficial in promoting the internationalization of the RMB.”

Is there any story in commodities these days that doesn’t come back to China?

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