How Does a Country’s Gold Reserve Affect its Economy?
Last month I watched one of James Bond’s movies called ‘Golden Finger’, which was produced in 1964. The story was about a villain who wanted to contaminate the US gold reserve in Fort Knox, his notion was to save gold bullions that will eventually multiply its price. As I was watching this movie, I wondered about the reason of any government to own gold, and how important is that process? What will be the consequences if the movie’s events occurred in reality?
At first glance you may think that all governments are rushing to own gold by all means; however, the fact is not exactly the same. Gold used to be the historical unique reserve asset by any government and civilians for decades due to its unique chemical specifications which made it unable to react with any element including acids, which made it a store of the value.
Nevertheless, that form was changed in the 20th century. All governments represented in their central banks or the treasury secretaries own a significant amount of reserve in the form of diversified portfolio of foreign currencies, foreign governmental bonds, and precious metals.
Most published researches and articles focus blindly on the gold amount owned by the governments regardless of how much gold represents of the total reserves. This research focus on the gold percentage compared to the total countries reserve, which will reflect the political and economical perspective of the policy makers of any country. The research classifies countries relation to gold reserves in two groups. First group is expanding gold policy countries; second, shrinkage gold policy countries.
The Gold Standard Era
Without delving too deep in history, in 1694 the Bank of England established the gold standard system to the world by replacing gold direct dealing with written banknotes to a promise of exchanging notes into gold when asked for that. This system was accepted worldwide, and stayed for more than two centuries to create an efficient economic system.
Under the gold system, the value of each currency was fixed in terms of gold, implied that the exchange rate between two currencies are fixed. The gold standard system put a lot of heavy weight on the big and smaller countries jointly. From the bigger countries side, the absolute ascending inflation for more than two centuries made the people doubt the capability of central banks in covering the banknotes into gold; as a result, speculators started selling off currencies to exchange it by gold. Such speculative actions depleted the central banks gold including BOE in the forefront. On the other side, smaller countries were enforced to raise their interest rates when rates were raised abroad; otherwise, it will find itself exposed to severe losses. Mass selloff of the local currency triggered the obligation of gold reserves or trade the local currency to other foreign currencies with higher interest rates.
During WWI the gold standard system was suspended by all countries, yet, the US remained on gold standard during the war. The war burdens left its shadows on countries, which were loaded by the war debts and hyperinflation. However, the most effected was the banking sector as many banks faced insolvency. By the end of WWI central banks made extensive efforts to reconstitute the gold standard system. Notwithstanding of printing large amounts of money bills during the war without its covering gold reserve, countries could reestablish the gold standard system. Despite these facts, the post WWI period lacked monetary stability, and countries including the UK itself seemed to give up the adoption of this system.
With the lack of political and ideological support of the gold standard system, central banks started to reevaluate its policies, especially after the world great depression era in the 30s. A significant amendments was made on the system by president Roosevelt.
Top Countries with Expanding Gold Reserve System
- Untied states of America
As the markets crashed in 1929, UK left the gold standard system after the frequent attacks made by the speculators effected the pound price to float and to determined by the market forces. Countries started to disbelieve in the gold standard system, and one after another gave up the system.
By the collapse of the pound against the gold, speculators started to focus on US Federal gold reserve, which refused to give up the gold standard system. The US took new actions to recover the world crisis. One of the actions was to raise interest rates that was below 20% in order to break down speculations against the dollar. As the government pressured the Fed, the Federal Open Markets operations Committee (FOMC) was established to increase supply by decreasing interest rates on governmental and corporate bonds. Eventually the Fed and the government realized that they were not on the right track and they have had to change something. They realized that the gold was the pivot point of the fiscal policy and nothing can be changed without system revision.
By the beginning of President Roosevelt period, reconsideration of the gold standard system was a priority. It didn’t take too long to recognize that lifting the gold standard up was a key element to recover the great depression. Straightaway, Roosevelt took a decision to let the dollar price float against gold by resetting its value at significant low level.
WWII burdens were insufferable, by that time every country took the decision to give up the gold standard system as it became very exhausting. In 1944, before the end of the war, the big governments signed the Breton Woods agreement, which stated currencies prices to be fixed to the US dollar instead of gold.
Nevertheless, the US Dollar should be converted in gold whenever there was a demand and gold to be priced at $38 per ounce. The final destination for gold role in the fiscal policy came in 1971 when President Richard Nixon decided to terminate the gold standard system and to replace it by the petrodollar system. Starting from that date, interest rates replaced gold and became the pivotal point of fiscal policy.
By that time, gold was out of the Federal Reserve fiscal policy; although the importance as a reserve asset did not diminish for the Treasury secretary. According to the world gold council, USA lead the countries gold reserves list. It stated that the USA holds 8133.5 (USD12 000 000 000) which consists 74% of the total reserves held by the treasury. The treasury is responsible to reserve the gold in deep storage since January 31 1934 in three places: Denver, CO, Fort Knox, KY, and West point, NY. US is the forth gold producer with 209 tons a year.
Moreover, If we’re consider the classification of gold percentage out of total reserves as no other country is keeping that high percentage of gold reserves but Tajikistan, the US is placed as the second on that list. A question should arise here, what does that means? a) USA, as the producer of the most dominating currency doesn’t need a large amount of foreign currencies. b) Gold has an inverse movement with the dollar, meaning that as the demand for gold rises by the treasury, gold price will go up and US Dollar will devalue. In other words, weakest dollar can boost economy, and higher reserved gold value.
- European Countries Using the Euro
Similarly to the US policy, the Euro considered to be one of the world economy columns. Despite the fact that ECB holds 26% of its gold reserves by 504 Tons, every country in the EU represents its treasury by holding a separate amount of gold reserves. The form of ‘sell Euros buy gold’ as a reserve is a common policy within Eurozone countries. Germany comes second on the list by holding 3377 tons representing 68.8%, followed by Italy with 2451 tons representing 67.8% of the reserves. However, Cyprus holds only 33tons, represents 64.1% of its reserves. France 2435T 63.8%, Netherlands 612T 63.9%, Portugal 382T 59.1% and Austria 280T 45%.
The European countries maintain structured formula to hold high gold reserves of their total reserves(commodities, currencies, etc.). As the Gold standard system rules global economy, a country must sustain gold reserves in order to control its currency and economy.
- Venezuela Learnt the Lesson
Venezuela, one of the top oil producer, was determined to hold anti-west policy, adopted the anti-dollar system by putting 64.8% of its reserves in gold instead of foreign currencies which represents only 187.5 Tons, the lowest in three decades.
That wasn’t the plan of Venezuela; in December 2009, Venezuela’s central bank released the “gold reorganizing”. They had a 10 year plan to increase gold reserves – they didn’t declare the amount they plan to increase due to the financial crisis and the decreasing confidence in USD, and they called this year “the year of gold”. Actually the plan worked for while, where the reserved amount rose from 355T to 365T by 2011; Nevertheless, it didn’t work for a long time. The country faced a severe crisis in 2016 caused a sell-off of two thirds of its gold reserves in a lower price than 2010.
As a result, the increased amount bought after the 2009 “Reorganization” was sold by loss, and Venezuela is classified as shrinking economy. Important lesson we should learn from the Venezuela model as we go through this research.
You may get astonished if you knew that Tajikistan, one of the poorest countries with 30% poverty, holds 81% of its reserves in gold, that puts it on the top of the list above USA. The 81% represents only 14.4Tones.
Tajikistan’s GDP was 7.8 billion in 2016, most depending on agriculture products and metals export. In fact, Tajikistan does not rely on gold for a reason, but because their main income rely on emigrated work force in Russia and exporting its product to neighbors countries like Russia, Turkey, Kazakhstan and Afghanistan.
Shrinking Gold Reserves Countries
- United Kingdom
On the other side of the coin it seems that some emerged economies have different point of view. Unlike the rest of Europe, UK has a different gold policy. The UK decided on the 7th of May 1999 to sell a big portion of its gold reserve in a short period to replace it by a basket of currencies including the new currency (Euro). UK gold reserves dropped from 590 Tons on 1999 to 310 tons today which represents only 8.6% of the UK reserve.
The decision was taken after new amendments made by the BOE. The policy targeted the high unemployment rates and price instability occurred in the mid 90s that formed a huge drop in UK exports. Graham Yong, a senior manager of foreign exchange division in the BOE, said about the change of UK gold reserves policy: “holding in the reserve is amid at achieving a return on them by lending a portion to the market”. However the UK decided to decrease 2/3 of its gold reserves, yet, the kingdom still ranked 17 on the list by amount not percentage.
- Commonwealth Realm
On the footsteps of UK, Canada and New Zealand followed, but more aggressively. Gold standard was adopted by Canada in June 14, 1853, and by 1999 the Bank of Canada decided to sell its gold reserves. The economic reasons that made Canada and New Zealand get rid of all of their gold reserves to be 0% remain unclear.
Australia is a country with a strong economy heavily focused on mining holds only 79.9 tons of gold reserve representing 6% of its allover reserves. Australia gold reserves raised slightly its gold reserves from 79.7 in 1999 to 79.85 in 2017. The Common wealth countries are some of the richest countries in gold mining field and hold the biggest portion of gold production combined. Australia is the second producer in the world with 270 Tons, Canada comes Fifth with 170 Tons, and south Africa comes seventh with 140 tons a year.
- Chinese and Russian axis
China was the last country to join the gold standard system in the early years of the twentieth century instead of the silver cover. China ranked Fifth by the amount of gold with 1842 tons of reserved gold representing only 2.6% of its reserves which connect China to the gold shrinking policies countries.
On the footsteps of China, Russia followed to be one of the shrinking gold policy countries by holding only 1645 Tones representing 16% of its total reserves; however, doubts relate to Russian numbers since the central bank of Russia shows different numbers than those claimed by the gold council.
Gold as jewelry retail sales, both in China and Russia is extremely popular and those considered to be the cheapest places to buy gold. China ranked first gold seller with 455 tons, Russia comes third 250 tons yearly.
The gold reserve is a wide topic and there are many subjects to be discussed. For instance, there must be connection among gold trade, gold reserves and gold prices. What are the effects of gold prices on governments reserved gold? and the most important question, what will be the impact after the end of raw gold? In general, I would like to sum up the main ideas of that topic:
- However gold never loses its value as a store mean, its role in current economy differs from age to age. It started as a coin in itself, and then turned to standard cover of banknotes, later it took different path by being used as governmental reserves and classical uses (jewelry and store of value) including the medical and automobile industry. Moreover, the relation between banks and gold also changed from phase to phase.
- We can classify countries regarding their gold reserve system into three types; a) USA and Eurozone that own the most desired currencies, have no way but to hold their reserves in gold and give a little space to less desired currencies. Bear in mind that USA is the fourth gold producer. b) Emerged economies such as the Commonwealth countries have different perspective by liquidating the reserved money to be used for development and other emerged countries had followed their footsteps – Japan and Switzerland. c) Emerging economies such as Russia, China and India adopt the same idea of the second group as an inevitable result to develop the currently stagnating economy.
- Venezuela is a vivid exam of failed policy, by which a country insisted to ignore the facts by challenging the international monetary systems and stagnating all of its oil income into gold only. That was one of the reasons that caused the country a severe crisis in 2015, resulted that the reserved gold was sold in lower price in 2016.