Why central banks are quietly buying gold (and maybe even Bitcoin)

Summary

The video explores the evolving role of gold, Bitcoin, and the US dollar as central bank reserve assets. After World War II, central banks held most of their assets in gold, but this has decreased drastically over the years. However, a shift is happening, with central banks increasingly buying gold and even considering Bitcoin. The video delves into the three main factors central banks consider when choosing reserves: safety, liquidity, and profitability. While the US dollar remains dominant, the video discusses the potential for gold and Bitcoin to play a larger role in the future as a hedge against geopolitical risks and sanctions.

Takeaways

• 😀 Central banks held over 70% of their assets in gold after WWII, but this decreased to under 10% by 2010. Now, central banks are beginning to buy gold again and even consider adding Bitcoin to their reserves.
• 😀 Central banks use reserve assets like gold, Bitcoin, and the US dollar to defend the value of their currencies during crises or to prevent rapid inflation, as seen in events like the Sri Lankan currency crisis in 2022.
• 😀 Reserve assets are crucial for preventing hyperinflation and helping countries pay foreign debts during currency depreciation, as seen during Mexico's 1994 tequila crisis.
• 😀 Central banks primarily care about three factors when choosing reserve assets: safety, liquidity, and making money. Gold and Bitcoin, while attractive, don’t meet all these criteria as well as the US dollar.
• 😀 The US dollar remains the top reserve asset due to its liquidity, with vast financial markets making it easy to buy and sell. Gold and Bitcoin are less liquid and are harder for central banks to accumulate or sell without driving up prices.
• 😀 While Bitcoin does not offer an interest rate like the US dollar or other fiat currencies, its potential for price increases makes it an attractive option for some central banks, like the Czech central bank.
• 😀 Safety is a top priority for central banks, and gold and Bitcoin's volatility make them less attractive. Fiat currencies like the US dollar are more stable and thus safer in times of crisis.
• 😀 The US dollar has advantages in both safety (due to its stability and physical safety in US custody) and liquidity, which makes it the most favored reserve asset for central banks.
• 😀 Central banks, especially those in emerging markets, are reluctant to buy large quantities of gold or Bitcoin due to their finite supply and high cost, whereas fiat currencies can be created in large quantities.
• 😀 The recent uptick in central bank gold purchases is partly due to geopolitical factors, such as sanctions or the risk of reserves being frozen. Countries like Russia have increased their gold holdings as a result.
• 😀 While Bitcoin is still too volatile for central banks to fully embrace, it may play a role in the future if it becomes more mainstream and liquid. The rise of cryptocurrencies might influence central banks to consider digital assets as alternatives to gold.

Q & A

Why did central banks hold a large percentage of their assets in gold after the Second World War?

After the Second World War, central banks held over 70% of their assets in gold as it was considered a stable and secure reserve asset that could help defend the value of their currencies.

What caused the significant decline in gold holdings by central banks in the decades after the Second World War?

The decline in gold holdings was largely due to the rise of the U.S. dollar as the dominant global reserve currency, supported by its stability and liquidity, which gradually made gold less essential for central banks.

What are the three main factors central banks consider when choosing a reserve asset?

Central banks prioritize three factors when selecting reserve assets: safety, liquidity, and the potential to make money.

Why are central banks increasingly interested in buying gold again?

Central banks are buying more gold, particularly in response to geopolitical tensions and sanctions that threaten the safety of their dollar and euro holdings, making gold a safer and more reliable reserve asset.

What role does Bitcoin potentially play in central banks' reserves?

Bitcoin is being considered by central banks as a digital alternative to gold due to its portability and potential to be more easily transferred across borders, though it remains highly volatile and less liquid compared to traditional reserve assets like gold and the U.S. dollar.

Why is the U.S. dollar still the most preferred reserve asset despite challenges from gold and Bitcoin?

The U.S. dollar remains the top reserve asset because it offers unmatched liquidity, stability, and safety. It is also deeply integrated into global trade and finance, making it the most reliable option for central banks to defend their currencies.

What are the potential risks of relying on gold or Bitcoin for central banks?

Gold and Bitcoin carry risks such as price volatility and difficulties in storage or liquidity, particularly for large-scale transactions. Gold is expensive to store, while Bitcoin's market can be easily affected by large sales, making both assets less reliable for central banks in times of crisis.

How does the flexibility of fiat currencies like the U.S. dollar contribute to their dominance as reserve assets?

Fiat currencies, like the U.S. dollar, can be created in large quantities by governments, making them more flexible and less volatile than gold or Bitcoin. This flexibility allows central banks to effectively manage their reserves and currency value, which contributes to the dollar's continued dominance.

What is the significance of the U.S. dollar's liquidity in global financial markets?

The liquidity of the U.S. dollar is crucial because it allows central banks to easily accumulate or sell dollars without significantly affecting their value. The massive size and openness of U.S. financial markets make the dollar the most liquid reserve asset in the world.

Will the U.S. dollar lose its position as the global reserve currency anytime soon?

The U.S. dollar is unlikely to lose its position as the global reserve currency in the near future due to its unmatched liquidity, safety, and network effects. Shifting away from the dollar would require a significant global transformation, which is expected to take decades, similar to how the dollar replaced the British pound after World War II.