The Role of Gold in Central Bank Reserves

James Steel

By James Steel
Chief Precious Metals Analyst, HSBC Bank USA NA

A Long History

Central banks and gold have a long history, although the use of gold as money predates established monetary authorities by millennia.

The use of gold by central banks has played a key role in shaping the modern world. The great period of global economic expansion between the end of the Napoleonic Wars (1815) and the First World War (1914) was arguably made possible in part by the introduction of the Gold Standard, a monetary system where a country’s currency has a value directly linked to gold.

The resulting currency stability allowed for a remarkable period of expanding trade and global investment. This dovetailed with the opening of massive gold deposits in the Americas, Southern Africa and Australasia, which compounded global expansion by effectively greasing the world’s money supply. The system was largely policed by the Bank of England with the co-operation of other central banks. This ended with the onslaught of the First World War as most belligerent nations suspended the free convertibility of gold. In the interwar period, the re-establishment of a gold standard by some nations met with mixed success. At the beginning of the 1930s, more and more countries were compelled to abandon the gold standard under the strains and stresses of the Great Depression.

After World War II, the Bretton Woods system was established with gold – once again – playing a key role in policies adopted by the world’s major central banks. Bretton Woods was based on an implicit pegging of currencies to gold. The currencies of participating central banks were pegged either to the US dollar or to gold directly. The system worked as the US held vast amounts of gold as reserves. The ensuing currency stability played a large role in securing the post-war economic recovery. The Bretton Woods system effectively collapsed in 1971 due to inherent contradictions and tensions in the system. Freed from the constraints of Bretton Woods, gold rallied considerably for the rest of the decade, boosted largely by double-digit inflation as central banks pursued expansionary policies. The end of Bretton Woods resulted in gold no longer playing a central role in the international financial system, moving bullion from the centre stage of central bank priorities.

That said, more than five decades after the collapse of the Bretton Woods system, gold continues to play a useful role in the international financial system and forms a notable share of global foreign exchange reserves. Purchases of gold by the official sector are an important (if sometimes little-discussed) component of gold demand. Collectively, central banks are the world’s largest holders of bullion, and their sales and purchasing decisions can have a significant impact on prices. Every independent central bank in the world holds at least some amount of bullion. Gold’s status as a currency is therefore borne out by the fact that bullion is counted as part of a central bank’s foreign exchange reserves. It is the only commodity-currency to have survived as money into the electronic age. This implies gold’s unique monetary status.


Why Buy?

Last year, central banks accumulated gold at the most rapid pace since the late 1960s, a period when the Bretton Woods system was drawing to a close. The official sector has not always been a bullion buyer, however. Where can we trace the comeback of gold with regards to central bank utility and interest? A long series of central bank gold sales, beginning in 1991, began to peter out in the early part of this century.

The official end of the Cold War in 1991 reduced geopolitical risks and ushered in an era of increased global trade and prosperity, which seemed to consign gold to the back burner. After decades of sales, central banks turned buyers towards the end of 2009, according to data from the Bank for International Settlements (BIS). The Global Financial Crisis in 2008 seems to have brought gold back to investors’ attention, including central banks. The end of mass central bank selling – almost exclusively Western European central banks who built up gold reserves during the Cold War – removed a significant negative from the bullion market.

Rank (2022) Central bank Official gold holdings (tonnes) % of FX reserves FX reserves (USDm)
1 United States 8,133.5 68.1 232,716.6
2 Germany 3,355.1 67.6 98,413.7
3 Italy 2,451.8 64.9 81,714.8
4 France 2,436.8 62.2 100,428.9
5 Russian Federation 2,298.5 22.2 497,946.0
6 China, P.R. (mainland) 2,025.4 3.7 3,188,790.0
7 Switzerland 1,040.0 6.9 847,164.4
8 Japan 846.0 4.2 1,178,279.4
9 India 787.4 8.4 521,528.0
10 The Netherlands 612.5 57.3 27,665.7
11 Turkey 564.8 29.7 82,890.0
12 ECB 506.5 33.0 -
13 Taiwan 423.6 4.5 552,201.0
14 Uzbekistan, Rep. of 384.4 65.8 12,702.7
15 Portugal 382.6 69.1 9,939.7
16 Kazakhstan, Rep. of 355.6 59.6 14,582.8
17 Saudi Arabia 323.1 4.2 471,575.7
18 United Kingdom 310.3 10.3 158,329.9
19 Lebanon 286.8 52.9 15,893.0
20 Spain 281.6 18.3 76,497.9

Table 1: Central Bank Holdings Around the World

Source: IFS, HSBC
The percentage share held in gold of total foreign reserves, as calculated by the World Gold Council. The value of gold holdings is calculated using the end of month LBMA Gold price published daily by ICE Benchmark Administration. In January 2023 the end of month gold price was US$1923.9/oz. Data for the value of other reserves are taken from IFS, table ‘Total Reserves minus Gold’.

Anatomy of Holdings

One of the most interesting features of central bank gold reserves is the broad, varied and unequal distribution of holdings. On average, governments hold around 10% of their official reserves as gold, but this varies widely, and holdings among the world’s central banks are highly skewed (see table 1). Those in the euro area, including the European Central Bank (ECB), own considerable amounts of gold. The US and Japan are significant holders also, with the US being the world’s largest official sector holder of bullion, accounting for a little under one-quarter of all central bank gold. The Central Bank Gold Agreement (CBGA) signatories, which are a subset of the euro area, hold about 30% of all central bank gold. Members of this group were significant sellers in the 1990s and the first decade of this century, and their sales patterns played a role in the bear market for much of that period. The CBGA, which regulated sales from signatories beginning in 1999 and was extended every five years for 20 years, officially ended in September 2019.

Despite robust purchases in recent years by emerging market (EM) central banks, holdings continue to be overweighed to OECD banks. Also, as a percentage of central bank total reserves, gold’s share has fallen over the decades (see graph 1).

Function Over Form

What is the rationale behind a central bank maintaining existing holdings or increasing gold reserves? And what has triggered a renewed period of bullion purchases? While gold no longer plays a pivotal role in international finance, it is still regarded as a valuable component of a nation’s foreign exchange reserves. Some of the reasons that reserve managers choose to hold gold include:

  • Portfolio diversification.
    Gold can serve as a portfolio diversifier and reduces the risk of holding currencies and debt instruments of other nations. Gold purchases can be a way of reducing heavy USD holdings. This appears to be an increasing reason in recent years.
  • Risk reduction.
    Gold does not have counterparty risk, which means holding gold does not bring any credit risk.
  • International payments.
    Gold can be utilised in a balance of payments crisis such as occurred in the 1997-98 Asian crisis and can be utilised to cover essential imports or shore up a domestic currency. It can also serve as collateral for loans.
  • Emergency funding.
    Gold is reliable in emergencies. In times of national emergency or conflict when national currencies may not be redeemable, gold can be mobilised.
  • Legacy.
    Many developed market central banks hold substantial amounts of gold by way of legacy, dating from decades ago.
  • Prestige.
    In the case of some EM central banks, there may be a tendency to emulate OECD gold holdings.

Non-OECD central banks such as the People’s Bank of China (PBoC) and Reserve Bank of India are moving up the league tables in terms of central bank gold ownership. Although some smaller EM central banks may hold relatively low amounts of physical gold, this may still translate into a large percentage of their total reserves, given correspondingly low currency reserves.

Despite its antiquity, gold is still a useful and robust component of a central bank’s portfolio, and holdings in many central banks are far from static. Reserve managers’ allocation decisions regarding gold depend on a myriad of factors including policy objectives, risk tolerance, costs and the like – but bullion’s status appears rock solid. As the global economy continues to evolve, economic and geopolitical uncertainties appear to be on the rise, creating an atmosphere where central banks may continue to seek gold.

James Steel

By James Steel
Chief Precious Metals Analyst, HSBC Bank USA NA

James Steel is HSBC’s Chief Precious Metals Analyst. He joined HSBC in May 2006. Previously Jim ran the New York research department for Refco, a large US commodities brokerage house, specializing in energy and metals. He also worked for The Economist in the Economist Intelligence Unit covering commodity producing nations and on the Middle East desk.

His primary duties at HSBC include the production of daily market reports, including long term outlooks for the precious metals markets. These include supply/demand and price forecasts, as well as qualitative analyses. He is a frequent speaker at commodities related conferences. He is often quoted in the financial media and frequently appears on Bloomberg and CNBC.

He is an economist by training and studied economics at undergraduate and graduate levels in London and New York.