Why is Gold held by the Central Banks?
If one has looked into the gold market in recent years, one will likely have read that central banks are net buyers of gold. After years of selling the yellow metal these powerful financial institutions are now buying gold and holding it. Central banks are the largest players in the gold market, and if they are buying gold there is likely good reason.
Central banks have a great deal of responsibility. These mammoth institutions are responsible for monetary policy in their respective nations. Some central banks may be responsible for monetary policy in a group of different nations, such as the European Central Bank.
The scope of a central bank’s duties does not end with monetary policy. These banks are also expected to monitor and encourage employment, keep currency values stable and control inflation. In addition, central banks act as the primary bank of governments and oversee and manage the bank reserve and credit systems.
In Canada, the central bank is the Bank of Canada. In the United States, the central bank is the Federal Reserve.
The Bank of Canada’s responsibilities fall into a few categories. Its principle role is “to promote the economic and financial welfare of Canada.” The categories for the Bank of Canada are as follows:
- Monetary Policy-controlling the money supply
- Financial System- promotion of safe and efficient financial systems
- Currency- Issuance of Canada’s bank notes
- Funds Management- The bank manages Canada’s foreign exchange reserves and public debt while acting as the fiscal agent of Canada
The United States Federal Reserve also has several categories outlined. These categories include:
- Production of price stability and employment
- Systemic risk control
- Supervision and regulation of banks and financial institutions
- Provide financial services to the U.S. Government
Although central banks have been net buyers of gold in recent years, some have a lot more gold than others. The Bank of Canada’s gold reserves, for example, pale in comparison to that of the United States. It should be noted, however, that the U.S. Federal Reserve does not own the gold but rather the U.S. Treasury does.
Whether through a central bank or a treasury department, many sovereigns own physical gold. There are many different reasons that these large financial institutions may own physical gold. Some of these reasons may include:
- Desire for credibility
- Desire for stability
- Reserve diversification
- Hedging purposes
Gold is symbolic of power, value, economic credibility and prestige. The yellow metal has been recognized a reliable store of value for thousands of years, and can be exchanged anywhere in the world without counterparty risk.
China and its recent gold buying activities are a great example of what gold ownership may accomplish. China has been buying large amounts of gold in recent years, and although they have not publicly stated their gold holdings, some estimates put their reserves from 3000-8000 tons. This gold acquisition is likely an attempt by Beijing to boost the credibility of its currency, the yuan. The yuan is on the verge of being accepted as a global reserve currency and part of the IMF’s Special Drawing Rights.
The yuan could, in time, challenge the dollar as the preferred global reserve currency. The more gold that China has in reserves, the more likely such a scenario could become due to the fact that gold is viewed as a relatively stable asset.
Because of its history, inherent value and relative stability, gold may potentially provide central banks with a means of reserve diversification as well as global credibility.