Why Are Central Banks Buying Gold?

As we’ve reported central banks globally have been piling in gold. The question is why?

The final numbers for 2022 will be in soon, but we already know that net central bank gold purchased will almost certainly come in higher than the 2018 net purchases of 656.2 tons. According to the Word Gold Council, 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.

Central banks added nearly 400 tons of gold in the third quarter of 2022 alone, according to data compiled by the WGC. This was 300% higher than Q3 2021 and came in as the largest quarterly increase in central bank gold reserves since the World Gold Council started keeping records in 2000.

Along with the typical purchases, there were large unreported increases in gold holdings in Q3. Central banks that often fail to report purchases include China and Russia. Many analysts believe China was the mystery buyer stockpiling gold to minimize exposure to the dollar.

And then in November, the People’s Bank of China announced its first official gold purchase since 2019.

Why are we seeing this big increase in central bank gold buying?

Economist Daniel Lacalle proposed several factors in an article published by the Mises Wire.

In the first place, most central banks hold the majority of their reserves in US dollars in the form of Treasury bonds. Many countries would like to be less dependent on the dollar given the fact the US government has weaponized the dollar. Many analysts have speculated that China is accumulating gold to minimize dollar dependence. Lacalle said holding dollars might have been a stabilizing factor in 2022 but that could change “if the next ten years bring a wave of money devaluation that has never happened before.”

Lacalle also cites the slow but steady movement toward central bank digital currency, noting that it would completely change the way money works.

By issuing a digital currency directly into a citizen’s account at the central bank, the financial institution would have all access to savers’ information and, more importantly, would be able to accelerate the transmission mechanism of monetary policy by eliminating the channels that prevent higher inflation from happening: the banking channel and the backstop of credit demand. What has kept inflation from going up much more is that the way monetary policy is passed on is always slowed down by the demand for credit in the banking system. This has obviously led to a huge rise in the prices of financial assets and still caused prices to go through the roof when the growth in the money supply was used to pay for government spending and subsidies.

If central banks start issuing digital currencies, the level of purchasing power destruction of currencies seen in the past fifty years will be exceedingly small compared with what can occur with unbridled central bank control.

In such an environment, gold’s status as a reserve of value would be unequaled.

Lacalle said we could be heading toward an unprecedented period of monetary devastation. This is another reason to own gold.

The Financial Times recently reported that central banks are already losing a significant amount of money due to the falling value of bonds on their balance sheets. Through the first half of 2022, the Federal Reserve lost $720 billion. Other central banks have reported similar losses. That means they will have to fill the gap. Lacalle points out that central banks can turn to their governments — in other words, the taxpayers.

The wave of monetary destruction that could result from a new record in global debt, enormous losses in the central bank’s assets, and the issuance of digital currencies finds only one true safe haven with centuries of proven status as a reserve of value: Gold. This is because central banks are aware that governments are not cutting deficit spending.”

Lacalle asks, “Why do central banks increase their gold purchases just as losses appear on their balance sheets?”

His answer:

To increase their reserve level, lessen losses, and foresee how newly created digital currencies may affect inflation. Since buying European or North American sovereign bonds doesn’t lower the risk of losing money if inflation stays high, it is very likely that the only real option is to buy more gold. … So, why do they buy gold? Because a new paradigm in policy will unavoidably emerge as a result of the disastrous economic and monetary effects of years of excessive easing, and neither our real earnings nor our deposit savings benefit from that. When given the choice between ‘sound money’ and ‘financial repression,’ governments have forced central banks to choose ‘financial repression.’

“The only reason central banks buy gold is to protect their balance sheets from their own monetary destruction programs; they have no choice but to do so.”