In this post, we are going to discuss a recent report from several economists who work at the New York Fed.
In it, the authors address the question is gold is beginning to replace the US dollar? So, we’ll talk about the report, their conclusions as well as what I believe is missing in their analysis.
What is the conclusion of the report?
I’m going to begin the post by discussing the author’s conclusion. In sum, the authors conclude that gold is still a very low percentage of a Countries Foreign Exchange Reserves, and therefore is no threat to replace the dollar. Foreign exchange reserves are assets that a central bank holds in a foreign currency such as bonds, commodities like gold or oil, or US dollars. Now currently, there are around 12 trillion of Foreign Exchange reserves with the US dollar composing around 7 trillion.
However, as we will see, the situation isn’t as straightforward, and some questions are omitted.
What does the report examine?
In the report, titled “Dollar Assets, Gold and Official Foreign Exchange Reserves”, the authors examine the question whether the demand for gold signals a move to diversify away from the US dollar.
There are several key things that are analyzed in the article.
The first is around the recent increase in central banks buying gold. According to the World Gold Council, global central bank gold purchases more than doubled from around 400 tons in 2021 to over 1000 tons in 2022 and 2023.
The authors analyze several reasons for this increase in gold reserves by central banks and highlight a few key reasons.
One is inflation. Second, is that gold is a safe haven. Third, central banks are buying due to recent sanctions the United States placed on Russia. Of course, Gold cannot be sanctioned.
The authors due to concede that gold buying is increasing, most notably and this is no surprise, but by countries that are least geo-politically aligned with the US such as China and Russia.
What mistakes do I think the authors made?
First, they conclude that only several countries are boosting gold reserves and that it doesn’t signify a trend among all the central banks. In my opinion, this is a bad assumption. What must be understood is that Russia and China are beginning the trend. Since they are buying more gold, they are leading the way, and this makes it easier for ither countries to follow suit. Many simply won’t right now because of the fear of repercussions from the US.
For example, the US could impose a devastating Tariff on a country that exports a certain good or goods to the US. It could cripple the country while barely affecting the US economy.
Second, they view gold as archaic. The authors note how gold is tough to transport and expensive store. I think this is an outdated and very typical perspective from those who don’t support buying gold or silver. While there are costs that come with storing gold, the fact is there are costs too with storing digital money, or US dollars.
Reasons to Buy Gold and Silver- Read here
In fact, I would make the argument that safeguarding checking, saving and other types of accounts at banks and financial companies cost more.
For example, there are costs such as software and databases. Even more expensive than this though is the staff that needs to be employed. These banks will have to continuously employ cyber security personnel, software engineers and others to keep the computer systems running and the money safe. Up front, building a high security place to store gold might cost more, but over time safeguarding US dollars in digital accounts will outpace it.
The third reason the authors contend that gold is not threatening the US dollar is the ratio of gold to foreign exchange reserves is still low. Right now, the number is currently around 10% and US dollars still comprise the majority of foreign exchange reserves.
However, this is somewhat misleading. For one, the authors indirectly imply that the number needs to be an overwhelming majority like the US dollar is now. This isn’t the case though, as the US and possibility other countries could return to a gold standard if that percentage went to 40%. In theory, it might not even need to go that high. In 1913, as the Federal Reserve came into existence, they built the rule that the Fed must hold 40% of its assets in gold. So, in theory, it is possible a return to a partial gold standard could be based on a percentage much lower than 40%. As long as not everyone wants to exchange at once, a 20% or 30% number could work.
The fourth thing I think is a problem with the article is they ignore trend. It’s true that the current state in the world is that dollars comprise a much bigger chunk of the pie. However, without question, the purchases of gold from Reserve Banks have spiked considerably in the last few years. There’s good reason to believe this trend will continue and other countries, besides just Russia and China, will be stocking up. Other large countries like Turkey have been buying up gold and other emerging markets like Thailand and Kazakhstan as well.
Why is this important?
To me this highlight one of the issues we see right concerning gold, the US dollar and the dismissive believe that the US economy is invincible. We’re already starting to see issues in our treasury auctions, especially with long term bonds like the ten years. Recently, the ten-year note hit 4.5% yield, a number not seen in over a dozen years.
China and Russia are surely dumping treasuries, but a more interesting example might be Japan. Currently the largest holder of US treasuries, yields on bonds in Japan have been rising, so it’s reasonable to expect their purchases might drop as well.
Can the US turn the de-dollarization trend around?
I don’t believe so. I believe the only hope at this point for the US dollar would be if countries outside the US experienced severe economic hardships and somehow, the US managed to avoid any pain. This is unlikely though as we are a country heavily dependent on imports and also seem to always be funding a conflict. This could make outside countries flock to the US dollar if their currency collapsed, but I think many countries will still avoid the US dollar as much as possible.
In sum, the authors analysis was good in the article, but their conclusion appears to be misguided.
