As of May 2019, gold is yet to break that $2,000 level, since it peaked back in September 2011. It can be easy for anyone who isn’t a gold bug to assume the yellow metal has had its day. Prices have remained range-bound for a number of years.
Some have gone as far as to say that the gold bull is dead. But is that really the case? If so, why have gold purchases by central banks been rising? Surely they would be putting their money into some other asset, if gold is dead?
In 2019 Q1 alone, central banks bought 145.5 tonnes of gold, a six-year high for first-quarter acquisitions. The World Gold Council has recorded a marked increase in central bank interest and buying of gold, particularly since early 2018. So what’s going on and how will all this impact on the gold price?
Russia and China lead the gold rush
China’s central bank has shown increasing interest in getting some more gold, having added 651.5 tonnes to what is estimated to be a total reserve of 60.62 million troy ounces (1,718.5 tonnes). That comes after several consecutive months of purchases.
Russia has joined in on the action – in fact the central banks of Russia and China are leading the way as the world’s largest purchasers of gold. It’s believed the Central Bank of Russia (CBR) has gold reserves worth as much as $487.8 billion as of April 2019. Russia is alleged to have dumped almost all its holdings in US Treasuries in favour of gold.
The CBR has favoured increasing its stock of gold reserves since the financial crisis of 2008, especially since the US and the EU placed hefty sanctions upon the Russian Federation, following the 2014 intervention in Crimea and Eastern Ukraine.
The Russian Ruble has lost some value since 2014, but Russia has never had a better reason to try and diversify away from the Dollar. This all leads to an important question: is China joining forces with Russia to move the world away from the Dollar as the global reserve currency?
Gold out of the limelight
The global economy has faced a great deal of turbulence since US President Richard Nixon withdrew the US from the Bretton Woods system in 1971. The Bretton Woods system was otherwise known as the “Gold Standard”, a currency mechanism which sought to maintain a stable value for the Dollar and all currencies pegged to it, following World War Two.
For over 20 years, the US Dollar was issued at a fixed value relative to gold, but President Nixon decided to sever this link. In the aftermath of this, inflation soared, as the Dollar was allowed to devalue. The Dollar effectively became fiat money, backed only by the quantity of paper money issued by the Federal Reserve, losing its connection to gold.
Despite zero-per cent interest rates for a time, as well as multiple rounds of quantitative easing (QE) since 2008, which sought to rapidly increase the money supply of Dollars flowing within the US economy, the US Dollar has remained as a global reserve currency.
Now with many commodities and assets valued in US Dollars, the rising global powers of China and the Russian Federation appear to have come to the conclusion that a significant shake-up is required.
In recent times, Russia and China have become increasingly interlinked economically, as a means of softening the impact of US sanctions and tariff hikes, especially following the election of US President Donald Trump in 2016.
But is it possible that Russia and China could venture into the digital realm and seek to supersede the US Dollar as a reserve currency entirely?
The US Dollar loses its shine
At the height of the financial crisis, gold seemed to be the perfect safe haven, as the world economy stood on the brink of a financial meltdown. Gold prices soared from their 1999 low point to up around $2,000 in 2011, as US lawmakers squabbled over raising the debt ceiling. Gold prices remain below this 2011 peak as of May 2019, but the US government debt is still there, and it’s actually still increasing.
President Trump’s tax cuts have led to the national debt swelling to over $22 trillion as of May 2019, with the potential for a debt ceiling showdown sometime this year, as a series of budget funding deadlines all fall into place.
Investors increasingly seek to find a perfect safe haven, free from the effects of stock market turbulence, trade wars and mounting national debt. The emergence of blockchain in the 2010s has disrupted the safe haven space, as new technologies allow people to invest their money into cryptocurrencies, which have the potential to shake up the global financial order. Just as gold is seen as a hedge against turbulence and inflation, cryptocurrencies offer a fresh break away from the monetary monopoly of central banks.
A flurry of cryptocurrencies has emerged in the last decade, with early success-stories such as Bitcoin, Ripple and Ethereum. However, countries such as China and the Russian Federation have taken active measures to limit the circulation of these cryptocurrencies.
Cryptocurrency crashes in 2013 and 2017 led to some claiming that the likes of Bitcoin were in the same predicament as gold. Despite this, UK Bullion suggested over a year ago that all was not as it seemed with gold and Bitcoin noting that there was much potential for gold and cryptocurrencies to be home to innovations that could help diversify portfolios in years to come.
But what if we go one step further, and imagine a merger between gold and crypto? Could Russia and China be the ones to instigate this merger at scale? At first glance, a Chinese-Russian cryptocurrency might sound unlikely. However, great strides have been taken in recent years, meaning that gold-backed cryptocurrency is a reality. If this model can be proved to be workable, it isn’t too much of a leap in imagination to see nations such as China and Russia coming together to usher in their own gold-backed cryptocurrency at a scale that could potentially even rival the Dollar.
Crypto-gold – how would it work?
For a gold-backed cryptocurrency to work, it would need the backing of a nation with significant gold reserves, some claim – China and Russia have been increasing theirs significantly.
State-backed crypto-currencies aren’t all perfect – as we saw with Venezuela, the petroleum-backed Petro cryptocurrency has failed, as it simply didn’t have what would be considered a viable public blockchain. It was little more than a new name to replace a currency the government devalued by as much as 96 per cent last year. Gold-backed crypto will need to be much smarter.
To actually work, any gold-backed cryptocurrency would require the gold backing it to be placed in some kind of international trust, protecting it from outside interference.
This isn’t the first time a country has sought to challenge the hegemony of the Dollar or other currencies. In 2000, Saddam Hussein famously made the decision to dump the Dollar and price Iraqi oil in Euros, limiting Dollar access into the oil markets from one of the world’s then-leading exporters of oil.
Some have even suggested that former Libyan dictator Muammar Gaddafi sought to introduce a gold-backed pan-African currency, the Gold Dinar, to limit the influence of the CFA Franc, a French-backed currency that is widely-used in multiple African countries.
Just a few problems…
However, before anyone considers joining gold and crypto in some idealised union, there are a few limitations that might make gold-backed crypto tricky. The United States holds as much as 75 per cent of its reserves in gold, making its gold holdings worth as much as $310 billion as of September 2018, according to the latest data.
Cryptocurrencies also have limitations of their own – if countries adopt a global cryptocurrency, how will it be kept secure? Will some countries have a greater stake in it than others? How can a gold-backed cryptocurrency survive, if the US decides to flood the market with gold?
Gold-backed crypto could be a viable alternative to the current Dollar-based economic regime, but the US remains a significant holder of gold reserves, and the will power needs to be there from multiple sovereign nations to really push for change, if any future currency is to become a suitable replacement for the Dollar.
For now, we can at least keep an eye on the gold price … whether for a gold-backed new global currency, or another economic motivation, central banks are buying up gold – something that could well impact on the gold price for investors the world over.