An overview of how gold will solve many of the issues created by the US Dollar’s reserve currency status for today’s emerging economies
Gold bullion investors have long anticipated the demise of the US Dollar and the recent developments in the East seem to be expediting the erosion of the US Dollar’s hegemony as reverse currency. The sanctions applied to Russia involved their US Dollar-denominated assets being frozen which put other nations on notice that the US administration is prepared to use the US Dollar as a political tool. This development preceded the fasted central bank gold bullion accumulation since President Nixon took the US Dollar off the gold standard in 1971.
The World Gold Council reported that Q4 2022 saw the fastest pace of gold buying by central banks in a single quarter since records began. This has been interpreted as a move away from the US Dollar by emerging economies as they swap dollars for gold bars. We are seeing more oil deals settled in local currencies that bypass the US Dollar too which is directly undermining the current reserve currency. It seems that the East has an appetite for something other than the US Dollar to facilitate trade in the region.
This development has not gone unnoticed by retail gold investors as the physical gold market in Great Britain tightened and sent premiums up across the board. Managing Director of London bullion company Auronumwas quoted as stating “The market for low-premium gold bullion coins really took off last winter with a shortage of fractional gold coins such as gold sovereigns in the market. In late summer 2023, we are only just noticing sellers coming back to the market to allow us to refill our depleted gold stocks”.
A reserve currency is very important for global trade as it allows importing nations to seamlessly purchase goods from exporting nations without worrying about having enough of the exporting country’s currency. A reserve currency ensures adequate liquidity is always available to settle trades between nations.
Many investors are questioning what will take the US Dollar’s place. An already existing currency is unlikely to be accepted because it gifts the issuing country an advantage over competing trade partners. Moreover, the issuing country can issue excessive currency in a similar way to what has been observed in the US. It is unlikely that all countries will adopt another country’s currency because it does not solve the concerns that emerging economies have with the US Dollar.
This gives way to a potential solution involving gold bullion. If a gold-backed currency were to be used in cross-border trade settlement, then all countries using the currency would be on an even keel insofar that no nation has a (dis)advantage over any other. The nature of a gold-backed currency keeps central banks disciplined as they are not able to use seigniorage profits to sustain trade deficits as is seen in the US, United Kingdom and other Western economies.
The trouble with a gold-backed reserve currency is that it prevents central banks and governments from having the power and privilege of issuing their currency. This prevents strategic devaluations or operating prolonged deficits and will be especially problematic during periods of economic crisis or war.
Allowing a central bank to manage its currency ensures that deflation is less likely in the economy if it can manage the growth of the money supply. Convincing a large batch of governments to cede this very important privilege is a very difficult task because adopting a currency backed by gold places policymakers into a fiscal straitjacket.
It seems that the most likely event, which can be seen by the Eastern Central Bank’s aggressive gold bullion purchases in recent quarters, is that gold will play a role in international trade for the coming decades. Brazil, Russia, India, China, South Africa and allies (BRICS+) nations are likely to be leaders in developing a new reserve currency that is backed by gold but runs in parallel with each nation’s existing currencies.
This will allow governments to continue to manage their home currencies but will require them to settle trade with other nations using the approved reserve currency which is backed by physical gold bullion holdings. The currency will effectively be a receipt for gold bullion and so new currency can only be issued if the physical bullion is available to underpin it. This is at odds with the current fiat currency system which does not have the same constraints.
No nation will individually be able to profit from the excessive issuance of currency like the US currently does. This ensures that nations that adopt this gold-backed currency for trade purposes are safe in the knowledge that no nation can freeze their assets or devalue them. The BRICS+ nations developing a currency backed by gold bullion is likely to change the dynamics of global trade and wealth as more nations bypass the US Dollar. Countries and individuals that have large gold holdings see their wealth rapidly increase as a scramble to secure physical gold bullion drives the price of gold higher than current levels.