Reasons for Central Banks to Increase Gold Reserves

2022/01/18 | Economy, Note, top news

Strategic Council Online - Opinion: The central banks in various countries have recently begun to increase their gold reserves, so that the reserves of this precious metal have reached their highest level in the last three decades. Such a trend becomes even more important when the measure of the central banks coincides with a reduction in the US dollar assets and in the midst of Federal Reserve meetings to decide on the US interest rates and purchase of bonds. Reza Majidzadeh – Director of Simorgh Development Working Group, Pasargad Millennium Plan Think Tank

Even though nearly five decades have passed since the dollar-gold relationship broke down, the connection between them is still of great importance. In fact, the relationship between gold and the US dollar is very old and there is an inverse relationship between them today; as the appreciation of the dollar will lead to lower gold prices. Likewise, if there is an increase in the price of gold today, it will indicate a weakening of the US dollar. The exchange rate equals the purchasing power of different currencies; that is to say, the exchange rate between national currencies is adjusted to match the price ratio of countries; but in practice, in the long run, the exchange rate is separated from purchasing power parity. However, changes in relative price levels are one of the determinants of the exchange rate; therefore, variables affecting the purchasing power parity and relative prices and prices of key elements (such as the interest rates) affect the relationship between currencies and the decision to exchange foreign exchange reserves or alternative assets (such as gold). In addition, the dollar is a dominant global currency, and the rise and fall of the US dollar is influential in determining the value of the currencies of other countries; but the increase or decrease of the value of gold has no effect on the value of the national currency of countries; particularly after the severance of the dollar-gold relationship by Nixon in the 1970s and the end of the Bretton Woods system, countries no longer need gold to back their national currency, and for national economies, gold acts as a safe and covert asset.

Given the widespread debate in the Federal Reserve for making decision over the interest rate, the gold market and gold reserves have become increasingly sensitive as political tensions over Ukraine increase the desire to buy gold among traders and the accumulation of gold reserves among central banks has increased. In fact, gold is considered as a safe haven before inflationary pressures and risk coverage in the field of potential tensions in Europe. It was at the September 2021 meeting of the Federal Reserve that the decline in bond purchases for November last year and the increase in the interest rate for this year was predicted. At the time, such forecast and warning led to a decline in the value of gold, but now, despite the decline and fluctuation in the value of gold, the World Gold Council has reported that the central banks have increased their gold reserves by more than 4,500 tons. Although the long-term roots of such a trend can be traced back to the 2008 financial crisis and efforts of the countries to accumulate safe-haven assets during the crisis, in the continuation of this trend, efforts of emerging economies to transit from pure reliance on the dollar system in global trade and finance have also been the bedrock of the increase in gold reserves.

Measures such as exclusion of the dollar from market transactions in China and the dominance of the yuan, along with the efforts of other countries to consolidate bilateral or multilateral currency pacts that have intensified since Donald Trump’s trade war, although not being able yet to seriously shake the position of the dollar as the dominant global currency, it marks the beginning of a process that reflects the simultaneous efforts of the emerging economies to de-monopolize international financial relations. Although such trends do not seem to lead to the replacement of another dominant currency in the international economy, the likely outcome will be creation of competing currency-trading systems that will reduce the transaction costs for the emerging economies, given the prospect of continuing economic-political tensions.

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