Why Are The Central Banks Buying So Much Gold Unless They Still Fear Inflation?

Why are global central banks buying so much gold unless they still fear inflation? The World Gold Council estimates that 120 tonnes of gold were added to global central bank reserves in the first quarter of this year and that’s a whole lot more than they used to buy.

In fact even since 2010 the central banks have increased their share of global gold demand from just two per cent to 14 per cent last year. It’s one reason why gold prices have held up recently despite a shift from retail investors to speculation in the final stages of the US and Chinese stock market bubbles.

Inflation hedge

For central banks gold is the classic hedge against monetary instability and against inflation, that is to say unwanted devaluation that puts up the price of goods in the shops. Gold will hold its value while paper money devalues and the nominal price of gold goes up and up.

Emerging markets, and we have to class China as an emerging this case albeit the world’s second largest economy, are playing catch up with the developed world in terms of gold reserves. They only hold around 10 per cent of foreign exchange reserves in gold by comparison to 70 per cent or more for countries like the US and Germany.

Monetary experts say around 15 per cent might be enough to maximize the benefits of gold holdings, and even the relatively new European Central Bank has 25 per cent of its reserves in Maynard Keynes’ ‘barbarous relic’.

The pressure to buy gold for reserves is becoming even more acute as the legacy of money printing is starting to turn into rampant global inflation, manifest first in equity and real estate prices. This is actually desirable because it is the only way to amortize the colossal debts of the world without bankrupting everybody.

But central banks know that if they are to manage another episode of inflation without it turning into a highly destructive hyperinflation then gold is the answer. Nowhere is this more evident that in the People’s Republic of China where official gold reserves of 1,054 tonnes are but a paltry one per cent of foreign reserves.

Chinese gold reserves

This figure has not been revised since 2009 and there is a lot of speculation about what it might be today. Could China now be closer to the US total of 8,000 tonnes in its vaults? It’s been an open secret for several years that China has been buying up any gold it can acquire.

Indeed an official announcement about the scale of its gold reserves is widely anticipated by gold bugs as a major inflection point for the price of gold, and that’s the main reason it has been kept secret of course. The Chinese wanted to buy their gold at low and not much higher prices.

Still the question remains: just how high will gold prices go when the precious metal becomes far more important again as a linchpin of the global economic system? $7,000 an ounce? $12,000? $24,000? Or $65,000 as one article suggested recently?

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