Gold bugs rejoice – central bankers think you’re on to something
Showing a remarkable lack of faith in their efforts to control the global economy, central banks have been piling into gold since 2008. John Stepek explains what’s going on.
Central banks have got the economy and markets covered.
They know what they're doing. Their theories are backed up by decades of academic research and expert advice.
Expert advice, as we all know, is completely apolitical, changes rarely, and never, ever does a complete U-turn, like I don't know telling us all to start eating butter after years of telling us not to, or something crazy like that.
So why worry? I mean, what kind of deluded neurotic doom-monger would keep hanging onto gold (as insurance, of all things!) in their portfolio with people of this calibre in charge?
Well, I hate to break this to you, but
Guess who's buying lots of gold?
In fact, says a new report from the OMFIF (Official Monetary and Financial Institutions Forum) research group, central banks have been buying gold at a rate of 350 tonnes a year for the last eight years. That takes us back to the sorts of levels we saw in the pre-1970 era.
OMFIF has looked at central bank behaviour and gold buying going back over more than a century (back to 1871, in fact). It's broken it down into seven "ages of gold'. There's some interesting stuff in there, but I'll only go back as far as post-World War II this morning, as that's the most relevant to today's topic.
So the fourth age of gold 1945 to 1973 covers the Bretton Woods era, during which gold reserves were rising, notes David Marsh of OMFIF, "with European countries and Japan amassing sizeable new post-war holdings as central banks exchanged surplus dollars for gold from the US Treasury".
Indeed, between 1950 and 1965, central banks and treasuries bought up more than 7,000 tonnes of gold.
But this all came to a screeching halt in 1971 when US President Richard Nixon severed the dollar's link to gold. Gold was no longer backing the world's reserve currency. Instead, it was backed by the faith in the US government "fiat" money.
"The fifth age" (from 1973 to 1998) wasn't what you'd call a smooth transition. The 1970s were stagflationary, replete with energy shocks, and marked by geopolitical conflict and domestic political tumult across developed nations.
But things started to settle down in the 1980s and gold lost its lustre, helped by US Federal Reserve boss Paul Volcker's determination to crush inflation and make the dollar worth holding.
Peak paper gold in the gutter
I'd argue that this period the launch and early years of the euro experiment was the "peak" fiat currency moment. That was also when chancellor Gordon Brown sold off a big chunk of the Bank of England's gold at its lowest price for 20-odd years. Gold's lowest point corresponded to paper's peak.
The two phenomena were related, of course. The gold was sold to buy euros. And it was all purely political the gold wasn't sold in order to get a good price, and the euros were bought to prop up the new currency in its early days.
It's also notable I think that European countries who didn't join the euro were prominent among those selling their gold to prop up the single currency. It's almost as though they were paying a loyalty penalty for their lack of commitment to le grand projet.
Trouble is, since then, the era of purely credit-backed currency has been found wanting. That great big blow-up in 2008, itself a direct result of efforts to reflate markets following the dotcom crash, unsurprisingly rattled faith in the global monetary system.
Not least, it seems, among central banks themselves. Since 2008, they've added more than 2,800 tonnes to reserves nearly 10% of the global total. China and Russia are the main buyers, but developed world central banks have been adding too, or at least keeping reserves static.
This is the longest period of sustained purchases since that 1950 to 1965 era mentioned earlier. As Marsh puts it, "this has restored the yellow metal as a central element of money management after four decades of attempted demonetisation".
Not unlike the Bank of England's decision to whack most of its pension fund money into index-linked gilts, it shows a remarkable lack of faith in its own ability to run the economy successfully.
And I'm not surprised. It's hard to see a route out of today's debt burdens. But I suspect that it will involve some major shift in the monetary regime. I'm talking along the lines of a wholesale shift that will in the future be labelled as an "era", in the same way as we label the Bretton Woods era now.
What will it look like? I don't know. An intense suspicion of cash and an increasing reliance on digital currency seems likely to be part of it, judging by the mood music.
But whatever happens, regime change is a chaotic period during which few things can be relied upon. So having a bit of gold in your portfolio just like our central bankers seems like a sensible precaution.
My colleague Dominic Frisby wrote about prospects for gold and gold miners in the most recent issue of MoneyWeek magazine. If you're not already a subscriber, sign up here to get a great deal a year's issues for just £69.