Central banks buy gold as dollar concerns mount

In a recent article published on Yahoo Finance, Bloomberg macro strategist Simon White highlighted the growing trend of central banks building up gold reserves. According to White, the move is driven by concerns about the possible erosion of the real value of the dollar due to persistently large US budget deficits and the threat of inflation.

White points out that while Federal Reserve Chairman Jerome Powell may not be overly concerned about inflation, as evidenced by his recent comments pointing to rate cuts later this year, other central banks are taking a more cautious approach. He argues that the new highs in gold prices indicate that global central banks are likely accumulating the precious metal to diversify from the dollar.

The Bloomberg strategist highlights the broad and pronounced nature of gold’s recent move, with the metal hitting 50-year highs against three-quarters of the major developed market (DM) and emerging market (EM) currencies. White notes that after jewelry, private investments including ETFs, bars and coins hold the largest share of gold reserves, followed by official central bank reserve holdings.

According to White, global central banks have continued to add to their gold reserves in the run-up to the pandemic and again after the start of the conflict between Russia and Ukraine, even as ETF investors, “perhaps blinded by the bright lights of crypto,” holdings have reduced. He notes that in the past six months, China, Germany and Turkey have increased their gold reserves the most, with China’s true reserves likely much higher than officially reported.

White explains that central banks want to hold gold as a hard asset that is not part of the financialized system when fully owned. However, he argues that the dominant reason for this preference is a desire to diversify from the dollar. For countries that are not on friendly terms with the US, owning gold allows them to avoid having their reserve assets confiscated, as happened with Russia.

Furthermore, White suggests that central banks worldwide are likely to be uneasy about owning too many dollars when the US is running large, inflation-inducing budget deficits. He points out that the dollar is structurally overvalued on a purchasing power parity basis against the major DM currencies and presents a chart showing the potential for dollar underperformance in the coming years.

White concludes by noting that while investors in gold ETFs may not perceive significant risks from inflation and the future of the dollar, central bankers are signaling a very different sentiment through their actions.