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April 26, 2023

Why emerging markets are stocking up on gold

By Phillip Meng

Last October, Ghanaian Vice President Mahamudu Bawumia announced that his country would seek to purchase oil with gold instead of US dollars. In support of this policy, Ghana’s central bank expanded its gold reserves for the first time since 1961, and the government plans to further boost reserves by requiring mining companies to sell 20% of their refined gold stock to the bank this year.

Accra is hardly alone in its enthusiasm for gold. Since 2008, emerging-market and developing countries have more than doubled their central bank gold reserves, led by Russia, China, Turkey, and India.

The end of gold demonetization?

Developing and emerging-market countries’ growing gold purchases have reversed a selloff in gold reserves—led by advanced economies—since the 1990s.

Starting in the mid-1940s, the Bretton Woods system linked most advanced economies’ currencies to gold, so treasuries and central banks accumulated large reserves to back them. But the system’s collapse in 1971 eliminated gold’s direct monetary purpose as a guarantor of currency value. Meanwhile, central banks’ success in controlling inflation in the late 1980s suggested that gold was no longer needed to rapidly raise capital for currency market interventions. And as interventions became less frequent, it became harder for central banks to justify large reserves in the 1990s.

Consequently, advanced-economy governments (which held 85% of all government-held gold in 1990) offloaded nearly one-fifth of their gold reserves from 1990 to 2007. Some, like the United Kingdom, swapped gold for foreign currencies. Others tried to get more creative: the Swiss government proposed establishing a foundation for Nazi-era victims with sale proceeds, although they eventually filled state coffers after voters rejected the idea. Apart from additional revenue, the sales offered practical benefits like reduced holding costs and lower exposure to gold’s notoriously high price volatility.

Emerging-market and developing economies largely followed advanced economies in demonetizing gold, though they had less of it to sell. Their gold reserves grew less than 10% during this period, even as their non-gold reserves expanded 25-fold.

Emerging markets’ new gold rush

What explains emerging-market and developing countries’ increased enthusiasm for gold since then?

First, the Global Financial Crisis weakened their confidence in the dollar-backed financial system’s stability—catalyzing a trajectory shift in gold purchases. In 2009, for example, China’s State Council announced that it had quietly expanded its gold stockpile by over 70% in previous years. Although China times its disclosures strategically—sometimes years apart—the announcement signaled an accelerated purchase program that persists today.

Second, the logic of returns may explain some diversification into gold. Years of rock-bottom interest rates on advanced-economy bonds increased the attractiveness of assets like gold, which can generate meaningful long-term returns. More recently, some central banks have reasoned that gold’s scarcity preserves its value as elevated inflation erodes Dollar- and Euro-denominated assets—although past returns suggest that gold is not an effective inflation hedge over shorter horizons.

Third, some countries have sought to reduce sanctions risk with gold reserves. Transacting with gold offers key advantages for sanctions evasion: anonymity, low traceability (especially if gold is mixed into alloys), and alternatives to Western financial centers where the US and its allies can more easily restrict trade flows. For example, Russia embarked on a major gold purchase program after US and EU sanctions for its annexation of Crimea in 2014. Since then, Russian entities have conducted gold-denominated transactions through hubs like Dubai to evade sanctions. Although gold’s bulkiness makes it an imperfect medium of exchange, several heavily-sanctioned countries have followed Russia’s lead in increasing gold’s share of foreign reserves.

Greater ambitions for gold

More broadly, countries with fractious US relations trust the dollar-backed financial system less, so it is unsurprising that gold purchases increase with geopolitical distance. Grouping countries by their degree of alignment with the US (represented by votes at the UN General Assembly, where “most aligned” states are in the top quarter of countries by voting alignment, “more aligned” are the next quarter, and so forth) shows that all but the “most aligned” countries have grown their gold reserves since 2008.

An important question is whether China and Russia will employ gold in their efforts to foster alternatives to the dollar—for example, by aiding the internationalization of the Chinese yuan. Outside of China, use of the yuan is hampered by Beijing’s capital account controls; foreign investors are reluctant to hold or trade yuan-denominated contracts without firmer guarantees of its convertibility. However, gold-backed yuan contracts could promise greater convertibility without requiring China to loosen capital controls. The Chinese government has already moved to promote the gold trade, establishing a yuan-denominated gold benchmark index in 2016 that makes it easier for Chinese market participants to exchange gold and influence prices, although further steps have been limited.

For now, emerging markets’ growing interest in gold is more a feature of the existing monetary system than a seismic shift away from it. Gold reserves still make up only 7% of emerging and developing countries’ reserves, and central banks may eventually decide that its clunkiness and price volatility are not worth the trouble. Diversifiers into gold believe that they can reduce their risks, improve their returns, or both. Whether these countries keep buying after inflation subsides will offer a clue into the staying power of gold’s appeal.

Phillip Meng is a Young Global Professional with the GeoEconomics Center.

At the intersection of economics, finance, and foreign policy, the GeoEconomics Center is a translation hub with the goal of helping shape a better global economic future.