The Changing Role Of Gold

As gold carries no credit or counterparty risks, it serves as a source of trust in a country, and in all economic environments. Making it one of the most crucial reserve assets worldwide, alongside government bonds.

For more on central banks gold holdings see the dashboard below: 

Central Bank Gold Holdings Interactive Charts

Therefore, the bottom line is that central banks are buying gold for many of the same reasons you and I are buying gold. Gold cannot be ‘printed’ by the Fed, the ECB, or any other central bank. In other words, this means gold is not subject to debasement.

And gold has attractive portfolio characteristics. In a central bank portfolio consisting of only a few currencies that might qualify as reserve currencies (i.e., the dollar, the euro, and the yen), gold provides excellent diversification characteristics. For example, gold is very inversely correlated to the US dollar, meaning that in general if the US dollar goes down that the price of gold increases.)

Gold and the International Financial System

Turning to the first question of what role can gold serve in the international financial system in the future?

Also, the fact that many central banks are again interested in gold for reserve purposes suggests that a new, semi-official, role for gold could emerge in the future.

One example of a role for gold is future inclusion in the basket of currencies that make up the International Monetary Fund’s (IMF) Special Drawing Rights (SDR) currency basket.

The SDR is an IMF-sponsored currency basket. Presently includes the dollar, yen, pound, euro, and renminbi (the basket weights of each are determined by the size of GDP, trade, etc.).

When first introduced in 1968 the SDR was meant to supplant the role of both the dollar and gold in central bank reserves. The SDR was initially referred to as ‘paper gold’, and its initial value was set equal to one US dollar.

 

Suffice it to say the SDR failed to supplant the dollar; the dollar is much more useful to central banks. As it can be widely invested and used in foreign exchange market intervention.

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