Central Banks And Gold – Study

Central Banks And Gold – Study

Central Banks And Gold

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Dirk G. Baur
University of Western Australia – Business School; Financial Research Network (FIRN)

July 20, 2016

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FIRN Research Paper


Central banks hold gold reserves that are designed to build confidence in fiat currency. This confidence is undermined if the price of gold falls significantly or rises significantly. Central banks thus have an incentive to manage the price of gold. Such management is evident in fixed gold prices in the early 20th century, in Central Bank Gold Agreements more recently and in the asymmetric correlation between monthly central bank gold reserve changes and gold price changes. The empirical analysis further analyzes gold lending by central banks, linkages between central banks, bullion banks and mining companies and the gold carry trade. We conclude that coordinated and shadowy gold operations by central banks are necessary for successful gold price and gold reserves management and demonstrate the power of market forces relative to central banks.

Central Banks And Gold – Introduction

Gold is the 3rd largest reserve currency after the US dollar and the euro with the US holding the largest gold reserves at close to 70% of its FX reserves (e.g. World Gold Council, 2011 and 2013). More surprising perhaps, gold is also among the most heavily traded assets in the world. The London Bullion Market Association (LBMA) estimates the average daily turnover at $240bn (LBMA, 2011) which is higher than the global daily turnover of any currency pair except for the dollar/euro, dollar/yen, dollar/sterling and dollar/Aussie dollar (Financial Times, 2011).1 The World Gold Council (2011) also argues that the liquidity and depth of the gold market is no coincidence in the context of gold reserve holdings by central banks as a liquid market is essential for a reserve asset. The current gold reserves of central banks indicate a significant role of gold. This role is not new. Central banks, monetary policy and the price of gold seem to have a long joint history as the price of gold was fixed to the US dollar for most of the 19th and 20th century. In the 20th century, gold was fixed at 20.67 US dollar until 1934 and at 35 US dollar until 1971.

This history of a tight connection between fiat currencies and the price of gold is possibly the basis for claims that the price of gold is controlled or managed still today. There is even an organization, the Gold Anti-Trust Action Committee (GATA), dedicated to the issue of gold price manipulation. An article in the Financial Times (Tett, 2011) summarizes the core argument by GATA and asserts that some of GATA’s “points have at least a grain of truth”. The “grain of truth” is related to the economic arguments underlying the manipulation claims, i.e. central banks control fiat money and the monetary system and thus have an interest in a relatively constant price of gold in particular a price of gold that does not rise by too much and too fast. In other words, gold is a currency that competes with other fiat currencies which is why central banks have an incentive to control or manage the price of gold.2 Martenson (2012) emphasizes this point as follows “If gold were suddenly to spike up to $5,000 an ounce, all sorts of troubling questions would emerge for people. Such as, is there something wrong with the dollar? Is the world falling apart? A rapid spike in the price of gold would certainly cause people to question the current state of the world of fiat money […]”. Doubts about the value of fiat money would particularly affect a country whose currency is a global reserve currency. Hence, the focus of manipulation is often on the US central bank.

Similar conclusions can be drawn for fast rising interest rates, inflation rates or exchange rates. These economic series are determined or influenced by central banks and governments yet generally no one claims that these series are manipulated. This perhaps puzzling discrepancy is potentially due to the limited information provided by central banks regarding gold reserves lending and gold’s global and supranational nature which makes uncoordinated and open management by any central bank difficult if not impossible. But not only a historically high price of gold or a fast rising price of gold would be of central banks’ concern, historically low gold prices or a fast falling price of gold would also be as it implies low valuations of central banks’ gold reserves.

This establishes a trade-off for central banks, i.e. prices should neither be too high nor too low, and provides incentives to manage the price of gold.

There are many official statements that illustrate that central banks acknowledge the role of gold for monetary policy and the existence of tools to manage the price. Two prominent examples are the following.

“There’s an interesting question here because if the gold price broke in that context, the thermometer would not be just a measuring tool. It would basically affect the underlying psychology. Now, we don’t have the legal right to sell gold but I’m just frankly curious about what people’s views are on situations of this nature because something unusual is involved in policy here.”(Fed 1993 (Greenspan, FOMC meeting 5/ 18/ 1993)).

“We can hold the price of gold very easily; all we have to do is to cause the opportunity cost in terms of interest rates and U.S. Treasury bills to make it unprofitable to own gold. I don’t know how much change in the fed funds rate and the Treasury bill rate it takes to do that, but I’d sure like to find out.” (Fed, 1993 (Angell, FOMC meeting 5/18/1993)).

Gold, Gold Manipulation, Central Banks

More recent statements by the former chairman of the US central bank, Ben Bernanke, draw a slightly different picture. When asked in 2011 whether gold is money he responded that gold is not money but an asset.5 Two years later, in 2013 when again questioned about gold, Bernanke said that “Movements of gold prices don’t predict inflation very well.” and that “nobody really understands gold prices” (see Wall Street Journal, 2013). These statements do not acknowledge the role of gold as an alternative currency or money which is a key premise in the rationale for gold price management or manipulation.6 A claim that gold is only an asset and does not possess any characteristics of an alternative currency is consistent with the view of manipulation advocates that gold has an important function in central bank decision making and that its role is systematically downplayed. In other words, if a central bank wanted to ensure that gold is not viewed as a thermometer for the value of fiat currency, it would try to decouple gold from the value of fiat currency or from consumer price indices. Finally, Bernanke’s statements do not explain why the “asset” gold is held in large quantities by the US government and why it is the 3rd largest reserve currency globally (World Gold Council, 2011).

Gold, Gold Manipulation, Central Banks

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