Central Banks Plan To Increase Their Gold Reserves In 2021- Here’s Why

Central bankers' interest in increasing their gold reserves made news again this week. Bloomberg’s headline on the topic was “Gold Regains Shine After Central Bank Buying Drops to Decade Low”. The article notes that 

Central banks may be regaining their appetite for buying gold after staying on the sidelines for the past year.

Central banks from Serbia to Thailand have been adding to gold holdings and Ghana recently announced plans for purchases. As the specter of accelerating inflation looms and a recovery in global trade provides the firepower to make purchases.

The National Bank of Serbia plans to increase its gold holdings from 36.3 tonnes to 50 tonnes because long term, gold is the most significant guardian and guarantor of protection against inflationary and other forms of financial risks.  

The recovery in global trade, along with higher oil prices are enabling central banks to start or resume gold purchasing programs. Which some countries, such as Russia put on hold during the Covid-19 induced lockdown restrictions because of the liquidity needed to support its economy.

Central banks hold reserves in gold as a way of diversifying from holding the reserves in other currencies, which are the liability of other central banks; mainly from holding US dollar assets, which account for around 62% of all foreign exchange reserves.

Central banks build foreign exchange reserves mostly through having an export imbalance, meaning that the country exports more than it imports. At approximately $3 trillion, China holds the most foreign exchange reserves.

Here is a simplified example of how these reserves are acquired: when a company in China exports to the US. The US company pays for those exports in US dollars. The Chinese company then deposits the funds into their local Chinese bank, and they are exchanged by the local bank for renminbi.

The US dollars deposited then get sent to the Chinese central bank who then invests in US dollar assets such as US Treasuries. However, both the US dollars and the US Treasuries are a liability of the US government and subject to the fluctuations of the US dollar for value.

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