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The Anything But the Dollar Club

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We’ve been following a number of central banks that have been buying gold recently, specifically the Russians and Chinese. But these two central banks aren’t alone. In fact, central bank gold-buying has surged over the last couple of years. What’s behind this trend?

In total, the world’s central banks accumulated 651.5 tons of gold last year. The World Gold Council noted that 2018 marked the highest level of annual net central bank gold purchases since the suspension of dollar convertibility into gold in 1971, and the second highest annual total on record. Russia was the leading purchaser of the yellow metal in 2018. Central banks in Turkey and Kazakhstan were also big buyers. We even saw increases in gold reserves from two EU banks – Hungary and Poland.

As we’ve been saying, these banks are seeking to minimize their exposure to US dollars. A recent article in The Street came to the same conclusion in rather colorful terms.

There was a point in the early 1990s when lunchtime London wine tipplers above a certain pay-grade would boast of being in the ABC club: ‘anything but Chardonnay.’ Now it seems central bank reserve managers have founded a rather less bibulous fraternity of their own, the ABD club: “anything but (US) dollars.” A snobbish revulsion to a grape that produces the finest white burgundies was largely pretentious. A reticence among reserve managers to increase US dollar exposure, on the other hand, can be viewed as economically rational. One big beneficiary has been gold.”

It’s pretty clear why countries like Russia and China would want to minimize exposure to the greenback given the United States’ propensity to weaponize the dollar. The fact that the primary system for facilitating monetary transactions globally uses the dollar.

SWIFT stands for the Society for Worldwide Interbank Financial Telecommunication. The system enables financial institutions to send and receive information about financial transactions in a secure, standardized environment. Since the dollar is the world reserve currency, SWIFT facilitates the international dollar system.

SWIFT give the US a great deal of leverage over other countries. The US has used the system as a stick before. In 2014 and 2015, it blocked several Russian banks from SWIFT as relations between the two countries deteriorated. Last fall, the US threatened to lock China out of the dollar system if it didn’t follow UN sanctions on North Korea.

The Street pointed out a more recent example of US bullying.

Volkswagon, Europe’s biggest carmaker, has been told to close its business in Iran due to US sanctions if it wants to continue to doing business in the US or accessing US financial markets. Volkswagen felt compelled to comply despite this being at odds with the view of the German government and the broader European Union.”

As The Street article points out, due to the dollar’s status as the reserve currency, the US also enjoys the “exorbitant privilege” of a constant demand for its currency. This enables the US to finance itself cheaply in global markets.

Interestingly, the use of the dollar in global trade is dropping. It currently makes up about 40% of SWIFT transactions. This is modestly lower than the peak in 2014.

There are also a growing number of efforts to circumvent the dollar system. The Russians have developed an alternative payment system that has reportedly surpassed SWIFT in popularity within the country. According to the Central Bank of Russia, 416 Russian companies and government organizations had joined the System for Transfer of Financial Messages (SPFS) as of September. And in September 2018, the EU announced plans to develop a special payment channel to circumvent US economic sanctions and facilitate trade with Iran.

As The Street notes, it’s not surprising that central banks most at loggerheads with the US are the ones most aggressively attempting to de-dollarize. The Russians have cut dollar reserves from 46% of their overall portfolio in 2017 to just 22% last year. The Russians have also increased their allocation to the Chinese yuan sharply over that timespan.

Over time the reserve holdings of dollars should broadly align with its use in trade. That is a significant (negative) adjustment. Yuan, copper, or other commodities may be an alternative to the USD for some investors. But conservative reserve managers are returning to an asset they know well. Since they turned net buyers of gold in 2009/10, the price has remained above $1,000/oz. That central bank bid and the ABCs of Anything But the Dollar should keep gold prices well supported.”

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