At a Glance
- A reticence to increase U.S. dollar exposure in 2018 resulted in highest central bank gold demand since the end of Bretton Woods.
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 U.S. dollar exposure, on the other hand, can be viewed as economically rational. One big beneficiary has been gold. Figure 1 shows central bank demand for gold in 2018 (651.5 tons) was the largest since the end of the Bretton Woods system of dollar convertibility into gold in 1971.
Store of Value
Post Bretton Woods and in the absence of a return to a Gold Standard, it has been hard to make the case for gold as an asset class. It yields nothing and its price is based on sentiment alone. Effectively all the gold ever mined is still in circulation, except it is not, because it is most often held as inventory, an economically inert store of value.
Approximately 3,500 tons of gold is mined each year, which is turned into trinkets and baubles, almost all driven by Indian and Chinese consumers, according to the World Gold Council. So why are central bank reserve managers, among the most sophisticated investors around, adding to their holdings of what John Maynard Keynes called a “barbarous relic”?
Anything But Dollars
ABD-itis has a lot to do with it. Since the introduction of the euro, the U.S. dollar has maintained its status as the world’s preeminent reserve currency, accounting for more than 60 percent of assets tracked by the International Monetary Fund’s Composition of Official Currency Reserves database.
This has meant the United States has continued to enjoy the “exorbitant privilege” of demand for dollars, enabling it to finance itself cheaply in global markets. But the use of the dollar in global trade is falling, down to just under 40 percent in 2018, according to international payments operator SWIFT.
Dollar as Foreign Policy Tool
The actions of successive U.S. administrations, which arguably have positioned the dollar as a policy tool, have not endeared it to other governments around the world. For example, Volkswagen, Europe’s biggest carmaker, has been told to close its business in Iran due to U.S. sanctions if it wants to continue to doing business in the U.S. or accessing U.S. financial markets. Volkswagen felt compelled to comply despite this being at odds with view of the German government and the broader European Union.
Extra-jurisdictional fines handed out to banks such as BNP Paribas, for behavior legal in their home countries, is another example of how the dollar has a role in U.S. foreign policy. Even the doughty Bank of England has been cowed into not repatriating $1.3 billion of gold held in its vaults by the Venezuelan central bank, something it is contractually obliged to do under international law, because of the threat of retaliatory U.S. sanctions on the broader UK financial system.
An Asset They Know
It is perhaps not surprising that the central banks of countries most at loggerheads with the U.S. have also been de-dollarizing aggressively. The Russian central bank has been the biggest net buyer of gold since 2009 and has cut its dollar reserves from 46 percent of its overall portfolio in 2017 to just 22 percent last year. Its allocation to the Chinese yuan (CNY) has also risen sharply.
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 ABD, should keep gold prices well supported.