Precious Metals

Report examines role of gold in currency systems

Gold will play a dominant role within a multicurrency reserve system, according to a report released recently by the World Gold Council.

Gold bar image courtesy of Agnico Eagle; background currency image in public domain.

Research conducted on behalf of the World Gold Council suggests gold will play a dominant role within a multicurrency reserve system.

In the summer edition of Gold Investor, Dr. Andrew Sheng, a distinguished fellow at the University of Hong Kong's Asia Global Institute, suggests the currency market is shifting toward becoming “multipolar,” still dominated by the dollar reserve currency bloc, followed by the euro currency bloc, but with the establishment of an RMB bloc representing Chinese currency playing an increased role.

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RMB refers to renminbi, the official currency of the People's Republic of China. The yuan is the basic unit of the renminbi, but is also used to refer to Chinese currency generally, especially in international contexts, where “Chinese yuan” is widely used to refer to the renminbi. 

Sheng explains that “the IMS [International Monetary System] relies on the dominance of the US dollar and the US has to run a current account deficit to supply the world with dollars. As we move to a multipolar system, that need should diminish. Ironically, however, the increasing importance of surplus economies, such as Europe, China and other Asian nations, has reinforced the dollar’s strength without alternative channels for surplus savings.”

Sheng further goes on to explain “there is no global central bank and no global fiscal policy. As a result, central banks and governments are forced to try and balance three, often conflicting, demands: portfolio management strategy, national risk management strategy, and global systemic stability.”

Sheng says nations are moving toward gold to more stably balance their portfolios. “The inherent weakness of this ‘non-system’ is clear, however, which may explain why many emerging market central banks are increasing their allocation to gold,” Sheng says. “It is liquid and has neither credit nor default risk. The inescapable conclusion is that the only viable alternative asset for official reserves is physical gold, as it alone has the requisite liquidity, correlation characteristics, and trust. Central banks seeking true risk diversification or insurance, therefore, should increase their gold holdings.”

Sheng notes that while China and India are the world’s largest consumers of gold, “China holds just 2.3% of its total reserves in gold, while India holds 5.8%. This compares to more than 60% in advanced economies such as the US, Germany, Italy, and France.”

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Sheng notes that additional research conducted for the World Gold Council indicates that “if central banks increase their gold holdings by 2%, 5% or even 10%, that can increase returns and reduce volatility over the medium and long term.”

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