By VW Staff
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?