Gold: Barbarous Relic or Central Bank Bedrock?

gold and the dollar

Gold: Barbarous Relic or Central Bank Bedrock?

December 10, 2019

For some years now - probably since 1971 when President Nixon cut the U.S. dollar’s link with gold - many central bank top executives have been seen to be downplaying the role of gold in the global monetary system, although perhaps not really believing this themselves. Yet most central banks have been retaining substantial amounts of gold in their reserves - and over the past few years an increasing number of banks have been adding to these gold reserves overtly, or perhaps surreptitiously. Indeed ever since the 2008 Great Financial Crisis (GFC) central bank gold purchases have been rising year-in-year-out. In the years prior to the GFC some central banks had been selling off some of their gold, but now the number actually adding to their gold has been rising by the year.

In recent years the media has reported that monetary gold has oft been described as an irrelevance in the modern financial system by many prominent bankers and economists. It has also been described as a ‘barbarous relic’ - a term originally applied by famed economist John Maynard Keynes to the ‘gold standard’ which had provided the backbone to many currencies for many years. The gold standard was particularly widely used in the 19th and early part of the 20th century, primarily by those nations whose currencies dominated global finance with their gold holdings giving confidence in them for those using these currencies in their reserves. However, most nations abandoned the old gold standard as the backstop of their monetary systems at some point in the 20th century, with the U.S. effectively being the final outlier up until 1971 when the demand for switching dollars into gold got out of hand. The gold link had led to the U.S. dollar becoming, de facto, the world’s principal reserve currency, although since 1971 reserve currencies are all fiat and thus only supported by confidence in the ongoing stability and assumed ability of the currency concerned to meet all, or any, obligations on it. The U.S. dollar has thus retained its dominance as a reserve currency given the U.S. is seen as the world’s strongest economy and thus good to meet any global commitments that may be entailed in its reserve currency obligations.

This was, perhaps, all fine in the days when nations carried relatively insignificant levels of debt, but since the GFC, national debt levels have risen exponentially which has again raised the specter of ever-reducing confidence in the ongoing value of currencies used in the world’s reserves and this may well have precipitated what now appears to be a flight into gold by an ever-growing number of the world’s central banks. This has been coupled with moves to repatriate gold holdings from the nations - primarily the U.S., the UK and France, which have traditionally held gold on behalf of others.

I am indebted therefore to Jan Nieuwenhuijs, writing under his own name rather than his Koos Jansen alter ego with which many gold followers will be familiar, who has been undertaking some research into the true opinions on gold of some key European central bank leaders. Notably he draws on the published views of Jens Weidmann, President of that most conservative of central banks, Germany’s Bundesbank. In his introduction to a book put out by the Bundesbank last year, Weidmann describes gold as the “major anchor underpinning confidence in the intrinsic value of the Bundesbank’s balance sheet.”

The Bundesbank book goes on to describe gold as “the bedrock of stability for the international monetary system.” When the German central bank, in particular, makes statements like this it is a very strong pointer to the real views of most conservative central bankers worldwide.

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But Nieuwenhuijs doesn’t stop with just reporting the attitudes of the German central bank. He comes up with gold supportive statements from other European central banks too. The Netherlands central bank, another extremely conservative body which has also repatriated gold from overseas vaults, notes “Gold is the perfect piggy bank—it’s the anchor of trust for the financial system. If the system collapses, the gold stock can serve as a basis to build it up again. Gold bolsters confidence in the stability of the central bank’s balance sheet and creates a sense of security.”

The Finnish central bank notes: “Gold is a genuinely global means of payment that has maintained its value throughout history.” and the Banque de France comments in its key facts on gold: “Gold is a highly sought-after precious metal, considered to be the ultimate store of value.”. It would not be too far-fetched to assume that many other top central bankers, if asked, would express similar sentiments,

With all these positive comments on gold, and taking into account the fact that most central banks seem to be, at the very least maintaining, or adding to, their gold reserves, we have to assume that they collectively see gold as a hugely important store of value increasing confidence in their capability of meeting any future financial commitments.

We shouldn’t leave out the International Monetary Fund (IMF) either. As well as holding over 2,800 metric tons of gold in its own right - a total only exceeded by the U.S., Germany and, possibly China, which is notoriously opaque about its true gold reserve position - the IMF also rates monetary gold and gold bullion as having no collateral risk and therefore right at the very top of its list of safe assets held by banks.

So what is our conclusion here? Despite the oft-quoted denigration of gold as merely a ‘pet rock’, or ‘barbarous relic’, most of the world’s top bankers would seem to rate it as the safest of all asset classes, and if they see holding gold as the best means of protecting their wealth, then this is probably the best guide an individual could have of protecting theirs. Maybe the upside potential is not as strong as some other assets, but then neither is the downside risk. It acts as true wealth insurance rather than a wealth gainer, and with many predicting a recession ahead and an equities market collapse in the near future, it is perhaps the most valuable investment you can make. As is the consistent mantra in Michael Lewitt’s rather right-wing, but excellent nonetheless, Credit Strategist financial newsletter: “Buy gold and save yourselves.”

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