In case you were wondering, central banks buying gold will not save their currencies. It may be exciting to hear that 2022 is the biggest year of central bank gold buying since 1968, but it doesn’t mean anything for their currencies, aka money substitutes, or gold substitutes. Sorry to burst your bubble, but the quick answer is no, it doesn’t help a currency when a central bank buys gold.
See -Gold Demand Trends Full Year 2022
So why are central bank people making a fuss about it? It’s supposed to be a headline that catches your attention, but it does not mean that these central banks are saving their currencies. Logically, why is that the case? It doesn’t matter how much gold is on a central bank balance sheet if that gold is not convertible into the liability of the currency itself.
If the central bank is using the gold as a way to tinker around with an exchange rate, then there is little meaning to the gold on a central bank balance sheet. If the central bank wants to utilize its gold reserves to stabilize its currency, it has to make it convertible to the public at a fixed ratio. The central bank balance sheet is the asset side of the liability which is the currency. They are both sides of the same coin, with assets on one side and liabilities on another side.
Just like you have assets and liabilities, your assets back your liabilities, and if you have debt, that debt has value in accordance with the assets on the other side of your balance sheet. With central banks, it’s a little bit different because they have debt on both sides of their balance sheet. The liability, the currency itself, is debt because it’s backed by debt, which is the government debt that is on their balance sheet.
As long as that debt can be paid, then that debt has value, but the sort of Mobius strip circle of monetary policy eventually will fold in on itself. But once it does, the only thing left is the gold on the central bank balance sheet, which is when all of the liabilities that remain in circulation have to be backed by the remaining hard assets on the central bank balance sheet.
In that sense, if a central bank has zero gold on its balance sheet, its currency will fall to zero. If a central bank does have some amount of gold on its balance sheet, then when the debt becomes worthless, the exchange rate between the gold on its balance sheet and the remaining currency units in circulation will be backed on a 100% basis and that is a gold standard set by the market.
It’s not that gold on the central bank balance sheet is useless or has no meaning, but it does not necessarily mean that if a central bank accumulates gold, its currency will be strengthened.
Let’s start with Turkey, which has been buying gold in order to tinker with its exchange rate. How is that working out for Turkey? Well, if we look at the currency, there are pretty obvious signs of hyperinflation, and the gold buying has not helped its currency one bit. If we step back from Turkey for a minute and see who has been buying, we can see that China is also buying a bunch of gold, apparently. People are speculating as to how much it has.
Here’s the thing about China: its currency supply is basically pegged to the dollar as well within a certain exchange rate, and since China’s economy as it is currently structured is entirely dependent on exports to the United States, which is why they have to keep the exchange rate with the dollar within certain windows, it has inflated its currency much faster than the US dollar. This is possible for economies like
Russia because they are so already isolated from the US Dollar and global supply chains already but it’s not possible at all for economies like China which are dependent upon the supply chain structure that currently sustains it.
In the end, the bottom line is that central banks buying gold will not save their currencies. It’s just another band-aid solution that will eventually fall off. So keep stacking gold, because the responsible stackers, large and small, will be the ones to buy it when central banks sell it all.
See the Video by Rafi Farber on YouTube