There are many reasons that the central bank purchases gold. These include rising interest rates worldwide and exchange rate risk. They also hold onto it as a safety net. In the past, these banks would have sold gold at high prices and converted the proceeds into paper money. But today, the central bank still holds on to gold as a hedge against future risks.
Exchange rate risk
The central bank has been buying gold for nearly a decade, a trend that continues today. According to the World Gold Council, central banks have become net buyers every year since 2008. Demand for gold rose from less than two percent of world total in 2010 to fourteen percent in 2014. The U.S. Treasury holds the largest official gold holdings, at approximately a third of the total global supply.
Central banks are responsible for overseeing monetary policy, setting interest rates, and controlling the printing and circulation of legal tender notes. They also manage a nation’s financial reserves, which include foreign currencies and precious metals. Last year, central bank gold purchases reached record levels, pushing global gold reserves to their highest levels in 30 years.
The primary function of a central bank is to promote stability and promote economic growth, and gold is a key part of that. It also helps to control the size of the market. In particular, emerging economies are vulnerable to free market excesses, and central banks can protect them from the ill effects of such excesses by owning gold.
The People’s Bank of China has been increasing its purchases of gold for years. The central bank expects to import a record 1,000 metric tons of gold in 2017. Historically, central banks have used gold as a way to increase their foreign reserve holdings. But with the recent financial crisis, central banks have become net buyers, rather than sellers.
Gold is attractive to central banks as it provides diversification benefits. In times of economic instability, central banks are exposed to pronounced fluctuations in currency value, which makes them vulnerable to devaluation. Gold’s scarcity and limited supply make it a natural inflation hedge. This diversification helps central banks manage their reserves and protect their currency against devaluation.
The World Gold Council reports monthly data on the amount of gold purchased by central banks. Its latest figures show that central banks around the world bought more gold in May. This marks the second consecutive month of increased central bank buying. The increase in gold purchases is part of the longer-term trend of central banks’ appetite for gold.
Rising interest rates worldwide
One of the biggest reasons for central banks to buy gold is that it is a highly liquid asset. As a result, it can provide a safe haven in an unstable economy. But central banks need to exercise caution. It is possible for prices to drop significantly if the central bank increases interest rates too quickly.
In recent years, the Russian Central Bank has been one of the largest buyers of gold. Last year, it surpassed China to become the fifth largest gold hoarder. It bought 224 tonnes of gold, which helped the country diversify its investments away from the U.S. dollar. The move came after the country sold a large percentage of its U.S. treasury holdings to raise cash.
Several central banks have added to their gold reserves in the past year. According to the Federal Reserve, they added 650 tons to their reserves in 2019. The same trend has been in place since the 2007-09 financial crisis, when central banks worldwide sold a net amount of gold. This buying spree has been led by China, Russia, Turkey, Kazakhstan, and Uzbekistan. In addition, central banks have repatriated gold that was previously held in London and New York.
Management of gold reserves
Central banks have historically held gold reserves as a form of safe-haven. Gold’s inverse relationship to the US dollar makes it a valuable collateral, particularly during times of market volatility. While traditional economic powerhouses, such as the United States, have largely withdrawn from the gold market, it still represents a substantial portion of a central bank’s reserves. In fact, the United States alone holds eight and a half tonnes of gold, equivalent to 78% of the country’s total foreign fund reserves. Germany, meanwhile, has 3,300 tonnes of gold, equivalent to about 74% of its reserves.
The European Payments Union (EPU) has played a major role in the accumulation of gold reserves in the eurozone. Since the member states had to offset bilateral surpluses and deficits against one another, an increasing portion of outstanding net amounts had to be settled in gold or dollars. Germany was a net-sovereign country within the EPU from 1951 until its dissolution in 1958.