In the first three months of the year, central banks bought a combined 228 tonnes, the most ever seen in a first quarter, World Gold Council data revealed.

This follows up on what was already a record year in 2022, during which 1,136 tonnes of gold worth some $70 billion were added to the banks’ reserves. Compared to the 450 tonnes bought during 2021, that represents a whopping 152% year-on-year increase!

The pace and consistency at which central banks are now accumulating gold, as far as we can tell, is unprecedented, given they’ve mostly been sellers throughout history. But the recent transactional trend, in particular over the past 30 years, illustrates a dramatic shift in the official attitude towards gold.

Back in the early 1990s and 2000s, central banks were continuously selling off gold as strong economic growth during that time rendered bullion less attractive than currencies in many places. Some, such as those in Western Europe, were even selling hundreds of tonnes a year!

Then the 2007–08 financial crisis came, triggering a complete 180 in the official banks’ approach to gold. From 2010 onwards, central banks have been net buyers on an annual basis. About 80% of the central banks currently hold gold as part of their international reserves.

What Makes Gold an Attractive Investment?

Gold is highly favoured by central banks due to its ability to retain value during times of uncertainty. Unlike currencies and bonds, gold is not dependent on any issuer or government, making it a reliable asset. Additionally, investing in gold allows central banks to diversify their holdings away from assets like US Treasuries and the US dollar.

Given the profound impact of the recent financial crisis, often regarded as the most significant since the Great Depression, it seems logical to accumulate gold for its safe-haven characteristics. However, there may be more factors at play that contribute to central banks’ interest in gold.

Indeed, according to data from the World Gold Council (WGC), central banks have been accumulating gold for over a decade, even during periods when the global economy appeared to be in good shape. This trend emerged well before the COVID pandemic and sanctions became prominent issues. Joe Cavatoni, the chief market strategist for North America at the WGC, highlighted that these crises served as triggers for the increased demand for safe-haven assets.

The primary catalyst behind this surge in gold purchases has been the “emerging market/developing economies.” These economies operate differently from Western banks as they face higher risks during geopolitical conflicts. Additionally, they tend to have a lower level of trust in USD reserves. As a result, these countries have actively sought to bolster their gold reserves.

De-Dollarisation: Shifting Gold Buyers

It comes as no shock that Russia and China have emerged as the most assertive purchasers of gold in recent years, collectively accounting for approximately half of the total tonnage acquired globally in the past two decades. Following closely behind is Turkey, which significantly escalated its gold purchases, reaching a remarkable 148 tonnes last year and securing its position as a world leader in this regard.

It is important to note that the statistics on gold purchases mentioned above only reflect the reported data from central banks. Analysts believe that countries like Russia and China may be purchasing even larger amounts of gold than what is publicly disclosed.

Industry experts suggest that the motive behind these purchases is to safeguard against foreign seizures. Many central banks aim to increase their gold holdings as a buffer against current and future sanctions. For instance, the Central Bank of Russia can use gold as a replacement for the USD, a strategy known as “de-dollarisation,” to circumvent Western sanctions in international trade.

UBS, via a Business Insider report, predicts that this trend of central bank buying is likely to continue due to heightened geopolitical risks and elevated inflation. The US decision to freeze Russian foreign exchange reserves following the conflict in Ukraine may have had a lasting impact on central bank behaviour.

In addition to these factors, there is an underlying motivation driving most of the gold buying by today’s central banks. Sanford Mann of Forbes Finance Council aptly describes the distinction: “Where US, European, and Asian banks tend to see gold as a historical legacy asset, EMDE (Emerging Market/Developing Economies) banks tend to see it as a strategic asset.”

Nicky Shiels, head of metals strategy at MKS PAMP, mentioned to Forbes that as globalisation accelerates, non-G10 nations are expected to increase their gold holdings as they “re-commoditise.”

Gold also serves as an excellent hedge against inflation. Over the past 110 years since the establishment of the US Federal Reserve, the purchasing power of the USD has declined by 99%, while gold has remained relatively unaffected by annual inflation. Inflation is a significant factor driving countries like Turkey, which experienced an over 80% rise in price levels, to purchase more gold.

However, if these motives do not fully explain the relentless and accelerated gold buying in recent years, there seems to be another, stronger motivation propelling central banks to acquire more gold. Despite the ongoing prevalence of risk factors like financial turmoil and inflation, the buying patterns display an additional motive that drives banks to accumulate gold.

One possible explanation, proposed by IMC, is that central banks are seeking to offset massive losses they have incurred over the years by using the increased value of their gold holdings. This involves utilising the “unrealised gains” in the gold market to write off sovereign bonds. This approach would be particularly applicable to European central banks, which accumulated most of their gold during the era of the Bretton Woods agreement when gold was valued at a mere $35 per ounce.

With the current price of gold at around $2,000 per ounce, central banks now possess unrealised gains worth hundreds of billions of dollars. These gains can be leveraged to cover debt. Given the record-high government-debt-to-GDP ratios in many countries, this is a critical moment for global central banks to consider writing off sovereign debt and providing relief to their respective governments.

The solution lies in a strategic adjustment of the balance sheet, a financial tool used by institutions to assess their financial health. Central banks, being significant entities, also employ balance sheets. These balance sheets consist of assets such as international reserves (gold and foreign exchange), domestic government bonds, and loans to banks. Liabilities include the monetary base (reserves and currency), a deposit account for the government, and equity. By manoeuvring their balance sheets, central banks can effectively utilise their gold holdings to address their debt obligations.

Below is a generalisation of what a central bank’s balance sheet could look like:

The crucial aspect to note here is that the total assets must always match the total liabilities in order for the accounts to remain balanced, as reflected in a “balance sheet.” Therefore, when a central bank writes off government debt (such as bonds), a corresponding adjustment must be made on the liability side to maintain balance through double-entry bookkeeping.

While it is technically feasible for the central bank to utilise its capital or equity for this purpose, doing so would create an insufficient buffer to provide substantial relief. Furthermore, operating with negative equity could potentially undermine the central bank’s credibility.

Expanding the monetary base is also not a viable option. As we have witnessed, the financial measures employed to stimulate economies during the COVID pandemic have led to elevated levels of inflation that central banks are currently striving to control.

This brings us to gold, which presents a much more favourable alternative due to its significant unrealised gains.

Gold Revaluation Account

Since gold is the only international reserve asset not issued by a central bank and cannot be generated through printing, there is effectively no limit to its value denominated in fiat currencies. Therefore, when the price of gold rises, as it has done this year, the value of gold on the asset side of the balance sheet increases.

To maintain balance in light of the increased value of gold, a corresponding adjustment must be made on the liability side. Central banks can achieve this by utilising a “gold revaluation account” (GRA) to record the unrealised gains (explained further below).

In a sense, a Gold Revaluation Account (GRA) functions similarly to equity, and it can impact a bank’s balance sheet by inflating it. This is because the GRA’s value is directly linked to that of gold, meaning that when the price of gold rises, the GRA also increases. However, if gold prices were to plummet, it could have a detrimental effect on the balance sheet, as the GRA could turn negative and erode the bank’s net worth.

Due to these implications, GRAs have been prohibited within the European Union. According to the current EU law, there is a prohibition on netting unrealised losses in any security, currency, or gold holdings against unrealised gains in other securities, currencies, or gold. In simpler terms, any unrealised gains in gold can only be used to offset unrealised losses in gold itself, not losses in assets like US dollars or European bonds.

However, rules are not set in stone, especially during times of mounting debt crises. Interestingly, GRAs have been used before. In the 1930s, central banks revalued gold after countries abandoned the gold standard and devalued their currencies in relation to gold. Eventually, banks reestablished their currencies’ peg to gold at a higher price, allowing GRAs to be utilised as desired.

Could European Banks Revalue Gold?

Although no central bank has openly discussed using GRAs to cover their own losses or cancel sovereign bonds, it does not mean that it is not being considered.

In a recent interview, the Governor of the Dutch central bank addressed the bank’s balance sheet, which has suffered losses and is nearing a negative capital position. DNB President Klaas Knot emphasised the solidity of the Dutch central bank’s balance sheet due to its gold reserves, with the gold revaluation account amounting to over 20 billion euros. While the GRA may not be counted as equity, it serves as a potential solvency backstop for the bank. When asked about the possibility of selling gold, Knot firmly stated, “No, we’re definitely not going to sell.”

This is significant because it indicates that the bank is aware of the GRA’s potential use as a solvency safeguard. After all, relying solely on taxpayers to bail out central banks and governments is not always feasible.

Another central bank that did not rule out a gold revaluation is Germany’s Bundesbank. When asked about this option, the bank responded by stating that they prefer not to speculate on potential decisions and that accounting rules are set by the ECB Governing Council within the limits established by the European Treaties. According to gold analyst Jan Nieuwenhuijs, this response can be seen as a signal to the market regarding the potential revaluation of gold, saving the Bundesbank the trouble of carrying it out themselves, such as printing money to buy gold. Nieuwenhuijs suggests that the bank is simply not ruling anything out based on the use of phrases like “at this stage” and “in general.”

Nieuwenhuijs also highlighted the views expressed by former Bundesbank President Jens Weidmann in 2018, referring to gold as the foundation of stability for the international monetary system and a major anchor instilling confidence in the intrinsic value of the Bundesbank’s balance sheet.

In addition, European central banks may have proportionally equalised their gold reserves among each other over the past decades based on their respective GDPs. Nieuwenhuijs speculates that this equalisation was done to ensure that all banks enjoyed a similar relative gain in their GRAs during gold revaluation.

Reevaluating Gold Beyond Europe

It’s not only European central banks that could consider reevaluating gold. Nieuwenhuijs revealed in a recent article that a Caribbean nation, specifically Curaçao and Saint Martin, managed to mitigate losses in 2021 by utilising a portion of their GRA. They simply sold a certain amount of gold held by the central bank to realise gains and immediately repurchased the same amount of gold, effectively offsetting their losses.

What about the Federal Reserve?

Shifting our focus closer to the USA, the situation becomes more complicated. The United States has long been opposed to a gold revaluation since the 1970s, as it would potentially undermine the dollar’s status as the world’s reserve currency.

Therefore, for the Federal Reserve to consider revaluing its gold, it would entail a separate balancing act beyond simply aligning assets and liabilities. However, time is not on their side given the deteriorating health of the US banking system.

This year, we witnessed two of the largest bank collapses in US history. The intense run on Silicon Valley Bank in March alone cost the Federal Deposit Insurance Corporation an estimated $20 billion to cover. During that month, the market value of American banks plummeted by at least $229 billion, representing a nearly 20% decrease.

The failure of SVB sheds light on an overlooked risk within the US banking system, particularly in relation to the Federal Reserve’s monetary policy approach. When interest rates were low and asset prices were high, banks like SVB heavily invested in long-term bonds. However, when the Fed began raising rates at an unprecedented pace, bond prices plunged, leaving banks with significant losses.

Under the current capital rules in the US, most banks are not required to account for the declining value of bonds they plan to hold until maturity. As a result, when they are forced to sell these bonds to cover deposits, these previously unrecognised losses become realised losses.

According to the FDIC’s estimates, unrecognised losses across the banking system reached $620 billion by the end of 2022, equivalent to about one-third of the combined capital cushions of US banks. However, some experts believe this figure is underestimated, with recent estimates suggesting that the outstanding losses could be as high as $1.7 trillion.

In conclusion, while European central banks have shown hints of considering gold revaluation by acknowledging the importance of GRAs and their gold reserves, the prospect remains uncertain. The use of GRAs to cover losses or cancel sovereign bonds has not been openly discussed, leaving room for speculation and uncertainty. Meanwhile, in the US, the opposition to a gold revaluation and the challenges faced by the banking system present additional complexities in considering such measures. The future of GRAs and gold revaluation remains a topic of ongoing discussion and potential reconsideration in the face of evolving financial circumstances.

The concerning aspect is that these unrecognised losses have the potential to escalate further. During the low-interest-rate period, many banks were encouraged to utilise deposits to purchase long-term bonds, leaving them susceptible to these losses.

Consequently, these losses would eventually impact the balance sheet of the Federal Reserve since, in essence, the US central bank acts as the lender of last resort to prevent bank runs.

According to a report by Thomson Reuters in March 2023, “The estimated level of unrealised losses on bank balance sheets and borrowing by banks at the Federal Reserve’s discount window and from the Federal Home Loan Banks (FHL Banks) point to a financial situation in which many regional and smaller institutions are in need of financial assistance — warranted or not.”

Recent analysis conducted by the International Monetary Fund (IMF) has also confirmed the existence of serious vulnerabilities within the US banking system. The following excerpt is from the IMF researchers’ report:

“First, a higher path for interest rates could reveal larger, more systemic balance sheet problems in banks, none-banks, or corporates than we have seen to date. Unrealised losses from holdings of long-duration securities would increase in both banks and none-banks, and the cost of new financing for both households and corporates could become unmanageable.”

In simpler terms, there is an inverse relationship between bond prices and interest rates. Therefore, when the Federal Reserve raises rates, it diminishes the value of assets held by banks, including its own assets.

Indeed, the Federal Reserve has incurred significant operating losses over the past six months, depleting its capital. Recently released financial statements disclose that the Fed carries $330 billion in unrealised losses on its holdings of Treasury and mortgage-backed securities.

However, Bill Nelson, chief economist at the Bank Policy Institute, suggests that after accounting for the appreciation in the Fed’s assets, the unrealised losses could be even higher, amounting to $458 billion.

Thomas Hogan, a contributor to The Hill, attributes these losses to the Federal Reserve’s quantitative easing programs implemented in 2020-2021, during which market rates on long-term Treasury bonds fluctuated primarily within the range of 1.5 to 2.0 percent.

At that time, the Fed profited from the difference between the higher rate it earned from its bond purchases and the lower rates it paid on reserves and overnight reverse repurchase (ONRRP) agreements, which were 0.15 percent or less.

However, now that the Fed has raised the interest it pays on ONRRPs to 4.8 percent and on bank reserves to 4.9 percent, it is incurring losses since the rates it earns on its quantitative easing (QE) purchases remain largely unchanged.

Hogan estimates that the bonds are yielding an average rate of 1.75 percent, whereas the average rate paid on bank reserves and ONRRPs is 4.85 percent. As a result, the Fed is paying approximately 3.1 percent more per year than it is receiving on its $7.88 trillion securities portfolio, resulting in a loss of $244 billion per year—a topic that seems to be overlooked.

Hogan goes as far as to assert that the US central bank is insolvent, owing the Treasury over $48 billion, surpassing the bank’s total capital.

In practice, the bank could create fictional accounts in the assets column, known as “deferred assets,” to offset the increased liabilities. The Fed describes deferred assets as “the amount of net earnings the Reserve Banks will need to realise before their remittances to the US Treasury resume.”

The advantage of deferred assets is that the Fed can continue its normal operations without disruption. However, considering the current 40-year high inflation, as pointed out by Hogan, its recent performance has been less than satisfactory. Additionally, the disadvantage is that, at a time when the Federal Reserve is already exacerbating the US fiscal position by raising interest rates (and consequently, interest payments on the federal debt), it is further depriving the Treasury of revenues by deferring them into the future. These deferred payments burden American taxpayers until the Federal Reserve’s remittances resume.

To put it simply, the Federal Reserve finds itself in a precarious situation. It has already accumulated $48 billion in deferred assets, and this amount continues to grow. The unrecognised losses, coupled with the rising interest rates and the Fed’s financial operations, have contributed to its current predicament. The implications of these challenges extend beyond the Federal Reserve itself, with potential repercussions for the stability of the US banking system and the overall economy.

Addressing these issues requires careful consideration and strategic decision-making. The Federal Reserve, along with relevant stakeholders, must devise effective measures to mitigate the impact of unrealised losses, reassess its monetary policies, and restore financial stability. Failure to do so could have far-reaching consequences, emphasising the importance of addressing these concerns in a timely and comprehensive manner.

Is it possible that the bank would consider revaluing its gold reserves to offset its losses? While this remains speculative, the potential is certainly there. It is worth noting that the United States holds the largest gold reserves globally, standing at 8,133 metric tonnes, which equates to approximately $474 billion in market value. It is important to mention that the US still accounts for its gold reserves based on a statutory price of $42.22 per ounce.

A New Gold Standard Emerges

While we can only engage in conjecture at this point, it appears that something significant is unfolding within the Eurozone. The recent buying patterns and increased use of gold as a hedge against economic risks hint at deeper motivations.

In the 1990s, many Western European central banks were selling off their gold reserves, aiming to equalise their holdings among one another and with major economies outside the continent. However, the 2008 financial crisis prompted a shift in their public stance towards gold.

In recent years, countries like Germany and France have been repatriating their gold reserves and bolstering their holdings to align with industry standards. This action, as highlighted by Nieuwenhuijs in a previous analysis, suggests that European banks are preparing for a potential new “gold standard” through a revaluation of gold.

For this to occur, gold would need to be distributed evenly among Eurozone countries to ensure equitable benefits. Nieuwenhuijs suggests that there may already be a mechanism in place to “harmonise” their gold reserves, pointing to statements found on various banks’ official websites.

In essence, Nieuwenhuijs proposes that there seems to be a guideline for Eurozone banks to hold an appropriate amount of gold relative to their GDP and total international reserves. When seeking confirmation of this “Europe’s balancing project” from a former central banker, Nieuwenhuijs was informed that they are not allowed to openly discuss it. However, the banker did imply the existence of such a guideline during the gold sales of the 1990s.

While the details remain elusive, these observations suggest that a coordinated effort may be underway within the Eurozone to establish a new framework around gold reserves. The potential revaluation of gold could play a role in addressing financial challenges and signalling a shift towards a different monetary system.

A more in-depth analysis of the data, which examines the gold holdings of Eurozone nations relative to their reserves and the ratio of total reserves to GDP, provides further support for Nieuwenhuijs’ hypothesis. According to his theory, the even distribution of gold reserves among nations in proportion to their GDP would facilitate a seamless transition towards a global gold standard.

In conclusion:

Its difficult to dismiss the significant increase in global central banks’ gold purchases, particularly during a period when they are experiencing substantial losses, as mere coincidence. By connecting the dots, we can infer that central bankers are likely contemplating a gold revaluation, even if they are unable or unwilling to express it publicly.

Furthermore, it is worth noting that this would not be the first instance of a gold revaluation in history. In the early 1930s, for instance, the US government required its citizens to exchange their gold for $20.67 per ounce, only to revalue it to $35 per ounce the following year, which eventually became the price used in the Bretton Woods system.

In recent years, we have witnessed similar actions, such as Turkey urging its citizens to sell their gold to the government to support the declining Turkish lira (notably, Turkey was the largest net buyer of gold last year). Therefore, the possibility of gold revaluation extends beyond specific regions and could potentially occur on a global scale.

These examples highlight the historical precedent and the potential for gold revaluation to address economic challenges and shape the future monetary landscape.

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