by Dave Kranzler, Investment Research Dynamics:
Gold’s status as a Central Bank and bank reserve asset is escalating. According to Bank of America, gold has surpassed the euro to become the second largest reserve asset after the U.S. dollar. To be more precise, B of A should have specified that it is the eastern hemisphere Central Banks that are diversifying out of the U.S. dollar and the euro and buying gold and yuan. Nevertheless, gold now represents 16% of global bank reserves. The dollar represents roughly 58% of Central Bank reserves, down from over 70% since 2002.
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Interestingly, Poland was the biggest buyer of gold in the second quarter this year (though we do not have access to the actual amount of gold that the PBoC is buying). Furthermore, Poland is insisting that the gold it buys is delivered to the country’s Central Bank rather than letting London banks “safekeep” the gold. In addition, Turkey has been a big buyer of gold. Also several African countries have announced Central Bank gold buying programs.
Though it might not happen this year or next, I think there’s a possibility that gold could overtake the dollar as a reserve asset, particularly if the reports that the BRIC/eastern hemisphere alliance of countries are considering a gold-backed trade currency come to fruition. Russia is hosting a BRICs Summit in Kazan, Russia October 22nd – 24th. There are reports that the discussion of a new trading currency is on the agenda, though I have not been able to confirm that first-hand.
Russia announced today (September 5th) that it will increase its daily gold purchases from $13.5 million to $93 million (1.2 billion rubles to 8.2 billion rubles) for the next month starting September 6th using windfall oil and gas revenue. The report was released by the Russian news agency Interfax. In my opinion, this is related to the eventuality of a BRICS gold-backed trade settlement currency, if not a full-blown gold-backed currency.
I bring this topic up because the Fed has painted itself into a corner. It’s under enormous pressure from the market and Wall Street to cut interest rates. But if it does that, it risks a rapid sell off in the dollar:
The chart above is a 5-year daily of the US dollar index. The dollar is currently testing the 100 level on the index, which has served as technical support since early 2023. If the Fed starts to cut, in all likelihood the dollar will drop to 90, where it was in mid-2021. That will send gold rapidly toward $3,000 and silver toward $50.
A decline in the dollar foments several problems. First, this likely would accelerate the decline in the use of dollars by global Central Banks as a reserve asset. Just as significant, if not more problematic for the U.S., a falling dollar and lower interest rates will make it even more difficult to attract foreign interest in funding additional Treasury debt – something which has already become problematic.
Finally, the Fed knows that inflation is running hotter than is represented by the CPI. Rate cuts will push real interest rates further into negative territory. Using the CPI, “real” rates are positive now. However, using a valid inflation index like the Shadow Stats Alternative CPI, real rates currently -3% using the 1990 CPI calculus and -6% using the 1980 CPI calculus. Negative interest rates fuel price inflation, which is part of the reason inflation has been “sticky.” Cutting interest rates will cause the real rate of inflation to accelerate.
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