The blistering rally in gold augurs ill for the power of the dollar

Not long ago gold seemed to have lost its lustre. In the decades after President Richard Nixon abandoned the gold standard in 1971, the yellow metal fell out of favour with central banks, which hoarded their reserves in dollars instead. In the 1980s and 1990s investors and households grew weary of its miserly returns. Goldbugs were dismissed as eccentric doom-mongers. Gold was alluring when forged into a shiny bauble and useful in specialist manufacturing, but it was hardly a serious financial asset.

How it glitters now. Its price has soared by a third since the end of 2023, reaching an all-time high of almost $2,750 per troy ounce. The rush has been fuelled by war, inflation and fiscal profligacy around the world, which have drawn in family offices and Costco shoppers.

Yet perhaps no buyers have been as voracious as the world’s central banks, which have hoovered up hundreds of tonnes of the stuff over the past two years. Gold now makes up 11% of their reserves, up from 6% in 2008. This shift brings with it important consequences for America’s dominance of the global financial system. Even as the dollar remains unchallenged as the world’s reserve currency, its power is diminishing.

For some central banks, the interest in gold reflects anxiety about the state of the world. Others have a narrower concern: that their reliance on the dollar, always uncomfortable and annoying, has become dangerous. Buying has been enthusiastic in China, India and Turkey, and it began to ratchet up in the spring of 2022, after Russia invaded Ukraine, and America and its allies sought to cripple Russia financially, using sanctions. These included freezing some $280bn in state assets held overseas, and kicking Russian banks off swift, an interbank messaging service crucial for making cross-border payments. Visa and Mastercard, American firms which process debit- and credit-card transactions in almost every country in the world, pulled out of Russia, too.

Hence the search for sanctions-proof alternatives to the dollar. Some central banks are buying physical bars of gold and attempting to ship them to vaults at home, suggesting that they want to protect themselves from economic warfare. Countries worried about America’s power are also trying to trade in their own currencies. According to the Federal Reserve, the share of Chinese goods trade invoiced in the yuan has shot up to a quarter, from a tenth in 2020.

Officials in Brazil, Russia, India, China and South Africa—which met this week at a BRICS summit in Kazan, on the Volga—are working towards a new set of cross-border payment rails that would circumvent the dollar-based correspondent-banking system which dominates today. A few years ago the idea that central banks might be able to issue tokens and use these to settle cross-border transactions quickly and cheaply would have been a pipe-dream. But the Bank for International Settlements (BIS), the central bank for central banks, has been developing such a system. It is being used for live test transactions. The BIS payments mechanism was not designed for the BRICS, but it could serve as a template for a new system.

What does all this mean for the mighty greenback? Ever since China emerged as an economic force, worries have swirled that the dollar would be displaced as a reserve currency, much as it itself supplanted sterling a century ago. But you need only look at central bankers’ actions over the past few years to see that there is no reserve currency of second resort. Central banks worried about sanctions are turning to gold, not the yuan. Rather than devising a whole new payments system, the bricS could have simply agreed to use one of their currencies for trade between them. They have not done so. Chinese manufacturers may be invoicing in yuan, but bilateral trade between Brazil and India is not going to be settled via Beijing.

The dollar will therefore not be dislodged as the world’s reserve currency. The technology might be ready, but to scale up new cross-border payment rails requires a degree of co-operation and trust between the BRICS that may not yet exist. Even if it did, many of the dollar’s privileges—greater purchasing power, lower yields—would remain.

Nevertheless, the power that has been conferred on the dollar by its reserve-currency status is diminishing. Central-bank reserves held in physical gold are out of Uncle Sam’s reach. As more countries settle more of their transactions without passing through the American banking system, sanctions will become less effective.

Clarification note (October 25th 2024): An earlier version of this article said the BIS payments system was ready to enter operation. It is being used for live transactions, but to become operational would require participants to agree to launch it.

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