International journal of economics & law

Vol. 1 (2011), No. 1 (1-170)

GOLD AS A FOREIGN EXCHANGE RESERVE OF

CENTRAL BANKS
Dragan Golijan, professor
Tijana oja, dipl ecc (Vii struni saradnik za upravljanje portfolijom)

Abstract: Gold, as a precious material, has always attracted attention and had one of the very
important roles in trade flows. Once, while there was no money in today's paper form, gold has
served as the primary means of payment. The role of gold is different today, though still
significant, especially in critical conditions that are characteristic of today's global economy. This
paper will make the parallels between the behavior of the BRIC33 countries, and their aspirations
for growth in share of gold reserves in the current circumstances, and the countries of Western
Europe, on the same basis, in the period after World War II, before the moment of the
introduction of convertibility of their currencies. In addition, it will indicate the transfer of gold
between countries, its movement through the recent history and present state and position of
the gold reserves.
Keywords: gold, international monetary system, the price of gold, foreign exchange reserves,
central bank

INTRODUCTION
The price of one ounce of gold today achieves record levels. Until a year ago price of an
ounce of gold stood at USD 930, while ten years ago was only USD 270. Today is at the
much higher level and record level of about US$ 1,300.
From the earliest civilizations, gold is considered very valuable metal. It led to the
conquest, the creation of the colonies, encouraged the search in remote areas, and even
inspired the great works of world poetry. Gold is used to represent the main means of
payment. Today it is used as well, so to say the currency, since it is used for making
jewelry, awards, medals, etc. In addition, gold is a safe haven for capital in crisis and
uncertain times.
Demand for gold, which recently has a strong tendency to increase, led to a record gold
price, as noted above. Gold buyers today are not just wealthy investors. Even ordinary
people who do not have huge sums of money available for business investment, buying
small amounts of gold on the stock market - largely because of expectations that they
will make a profit on this investment. Most analysts predict further expansion of the
gold price. Forecasts ranging up to USD 1,500 - USD 1,600 per ounce of gold.
The fear of inflation also affects the growth of gold prices. In accordance with the
present conditions, some analysts predict short-term inflationary pressures in the U.S.
and other developed countries. On the other hand, some analysts estimate such a
scenario in which unsustainable debt of the United States and Europe affect the central
bank to carry out a devaluation of their currencies. Such moves could lead to
hyperinflation like those in Latin America during '70s and '80s, and in Germany
between two wars - which would be reflected in the drastic rise in the price of gold.

33

BRIC Brasil, Russia, India, and China

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International journal of law & economics

Vol. 1 (2011), No. 1 (1-170)

Historically, the price of gold is rising when U.S. dollar is falling and vice versa.
However, in recent times that is a situation where the dollar and gold rise in parallel,
where it has nothing to do with the weakening dollar, but euros, analysts said. How long
will the gold price to record growth no one knows that and that cannot be determined
with precision. This paper gives an overview of the movement of gold, as foreign
exchange reserves, starting in 1948, until today, in fact, ended in 2010.. Specifically
cover different periods that were crucial in the movement of gold - primarily the Bretton
Woods International Monetary System - to 1971, with emphasis on the crisis of the
international monetary system 1966 -1971. After that, it describes the movement of gold
between the 1971 1997, in what was seen as reducing the role of gold. Also, it is
extremely important moment of migration of gold from Europe in the southern
countries, strengthening the of gold BRIC countries position, and the question of
signing the Golden agreement of central banks.

GOLD AS A FOREIGN EXCHANGE RESERVE OF CENTRAL BANKS

If we look balance sheets of central banks and other financial institutions, which have
this precious metal in their portfolios, the structure of their monetary aggregates M1, we
notice that the largest reserves of gold located at the Fed, the Bank of Italy, the Central
Bank of Suisse, Central Bank of France, and Bundes bank. Among central banks and
countries with less than gold in their portfolios are the Central Bank of Japan, the Bank
of England, and the Central Bank of China, which recently rapidly increase gold
reserves. Since gold has no longer a critical role in the monetary system, as was the case
in the system of Bretton Woods, similarities between this system and the BRIC
countries of postwar Western European nations is now being observed. In both cases,
countries are accumulating gold, which implied more rapid economic development and
contributed to strengthening the credibility of the currency.
Although the gold reserves held by central banks, the way of using them depends on the
policy of the country which has a key role in reaching gold decisions. If the central
bank is independent, it can lead to tensions between monetary and the legitimate
government on the issue of which strategy to adopt when trading gold.
In the case of the Eurosystem, the revenue from the sale of gold is intended for the
central banks that made the sale. However, the main shareholder of the country is the
central bank and it is an indirect recipient of the sales revenue later. According to the
IMF report, in September 2010, total world gold reserves are recorded level of 30,535.6
tons.
The largest share of total reserves of gold had U.S., the IMF, and Germany.

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International journal of economics & law

Vol. 1 (2011), No. 1 (1-170)

This data is evident from Table No. 1

Ounces
of gold Gold/tons
in mil.

The share
The value
The value of Reserves of of gold in
of the
The share
gold (in % of
foreign
gold
reserves i
of gold in
central bank
exchange
GDP in %
(USD*
(in %M1) reserves in
balances)
billions)
%

USA

261,50

8.134,20

357,50

15,30

20,50

75,30

2,50

Germany

109,40

3.402,10

149,50

17,00

9,70

70,40

4,40

IMF

90,80

2.823,10

124,10

2,30

N/A

N/A

N/A

Italia

78,80

2.452,10

107,80

24,10

9,70

22,40

5,00

France

78,30

2.435,60

107,00

17,10

11,00

58,50

4,00

China

33,90

1.054,50

46,30

1,20

1,30

1,70

0,90

Switzerland

33,40

1.040,20

45,70

15,30

10,30

16,50

8,10

Japan

24,60

765,30

33,60

2,40

0,50

3,00

0,60

Russia

24,30

756,10

33,20

6,30

10,70

6,80

2,60

Netherlands

19,70

612,50

26,90

14,20

6,30

58,20

3,30

India

17,90

557,80

24,50

15,70

1,30

9,20

1,80

ECB

16,10

501,50

22,00

0,70

N/A

N/A

N/A

Great
Brittany

10,00

310,30

13,60

3,40

0,80

17,60

0,60

* Value of an ounce of gold is $ 1,367.00

Source: Natixis, Economic Research, 19/01/2011, pp.2.

GOLD RESERVES IN THE BRETTON WOODS SYSTEM

It is generally known that the Bretton Woods system was formally established after the
Second World War and stayed until 1971. The system has implied the introduction of
gold - exchange standard, where parity of national currencies is assessed and expressed
in gold or dollars. Countries have their currencies exchange rate pegged to the dollar,
given that the dollar was freely convertible into gold (at a fixed rate $ 35 per ounce of
gold), therefore, all countries, and the rate of their currency was pegged to the dollar,
had a fixed value in terms of gold. Exchange rates were not strictly (rigidly) fixed but

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International journal of law & economics

Vol. 1 (2011), No. 1 (1-170)

fluctuation (deviation) ranging from 1% up and down from parity were allowed.34 To
member states were allowed to carry out the initial exchange parities of their currencies
in the face of severe balance of payments difficulties (fundamental disequilibrium of
balance of payments).
At the end of World War II the U.S. held about 75% of total gold reserves (21,700 tons),
which is justified given that the dollar was the center of a new international monetary
system and other things, the full convertibility into gold. Dollar, as the only currency
that could be freely converted into gold has become an international reserve currency
(fixed exchange rate of exchange was U.S. $ 35 per ounce of gold.). During this
period Great Britain was the second largest owner of gold reserves, where having only
5% of total gold reserves. Meanwhile, Switzerland has, for its neutrality during World
War II and the geographical position take third place in terms of gold reserves. Swiss
gold reserves amounted to 4% of total world gold reserves.35 From World War II
Europe came completely destroyed. Difficult period of economic growth in Western
Europe contributed to the fact that the slow accumulation and generating foreign
currency reserves in dollars. Since 1958, when European currency could again be
converted to dollar, foreign currency were piled up in the U.S. and they were massively
converted into gold at the Fed, which resulted in the reduction of gold in the U.S.
Following chart shows the movement of gold in 1948 1965:
Chart 1: Trends in gold in tons in period 1948-1965

Source: Natixis, Economic Research, 19/01/2011, pp.3.

As noted, the curve that follows the movement of gold at the Fed, USD, records a sharp
drop from 1958. This trend continued until 1971. On the other hand, the EEC had a
tendency to increase gold reserves. As for European countries, it shows that all countries
which have been captured in the analysis, recorded increase in gold reserves. The
biggest trend was recorded in Germany and France.
34

Acin,.,Meunarodni ekonomski odnosi, Pigmalion, Novi Sad, 2003. godine, str.183.

Bordo, D.,M., Dittmar, R.,Gold, Fiat Money and Price Stability, National Bureau od
Economic Research, Cambridge, 2003. str.13.
35

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International journal of economics & law

Vol. 1 (2011), No. 1 (1-170)

THE CRISIS OF THE INTERNATIONAL MONETARY SYSTEM, THE

PERIOD 1966-1971
In general, the international monetary system has become unstable over time, a
significant part as a result of spending significant sums of money for financing the war
in Vietnam. International monetary system was attempting to reconcile the two
opposing goals. On the one hand, in order to gold-exchange standard function correctly,
the U.S. must been able to protect USD/gold parity, which required a strict monetary
discipline on their part. On the other hand, from the moment when dollar became the
international currency and reserve, the U.S. had to offer dollars to the world in order to
maintain growth throughout the country and avoiding the risk of deflation. In line with
this, the U.S. had to accept a high current account deficit. As long as the relation
between the dollar and gold reserves in the United States was 1, there was no doubt that
the U.S. cannot guarantee for USD/gold the exchange rate.36
In order to save the international monetary system, the countries of Western Europe
have agreed that in 1966, suspended the ability to convert dollars into gold, while the
U.S. opposed the current rate of exchange, i.e. the existing fixed exchange rate - USD
35 per ounce of gold. U.S. President Nixon's decision to suspend convertibility of
dollars into gold in 1971, which marked the collapse of the Bretton Woods system.
After that, on the scene came fluctuating exchange rate and gold no longer had initially
significant role in the monetary system. At the end of 1971, United States possessed
9,000 tons of gold.37
Chart 2: Gold reserves in period 1966 1971 in tons

Source: Natixis, Economic Research, 19/01/201, p.3.

36

Since 1964, this ratio was below 1. However, in period 1970 1971, this ratio recorded level of
5. These movements in Bretton Woodss system were named Triffin Dilemma.
37
Barro, Robert J. "Money and the Price Level Under the Gold Standard," Economic Journal, 89
(1979), 12.

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Vol. 1 (2011), No. 1 (1-170)

PERIOD OF REDUCING THE ROLE OF GOLD - 1971 - 1997

As gold was losing a key role in the international monetary system, in its place is slowly
coming dollar. These movements were so radical that the IMF, under pressure from the
U.S., continued its solid sales of its gold reserves, since 1976, and during the 1978, and
has changed the articles of the IMF agreement in order to prevent other countries to bind
their currencies to gold.38 Central banks of Western countries recognized the
stabilization of its gold reserves and modified them slightly only in urgent cases.

REMOVAL OF GOLD FROM EUROPE TO MARKETS IN

EXPANSION SINCE 1998
Diversification of foreign exchange reserves of southern countries, since '90s of the last
century showed expansion, and their willingness to increase the credibility of their
currencies, have influenced the increase in gold reserves in these countries. Gold,
bought by these countries, mostly comes from the northern countries, primarily
European. Between 2002 and 2010, these countries have bought following amounts of
gold:39
- China bought 553.5 tons of gold;
- Russia increased its gold reserves for 127.3 tons (annual growth of 27.6% in 2010);
- India increased its gold reserves for 200 tons (annual growth of 56% in 2010).
Reserves of gold in the countries of Europe have recorded following movements:
Chart 3: European and BRIC reserves of gold in period 1998 2010

Source: Natixis, Economic Research, 19/01/2011, pp.4

Germany is, as you can see from the graphical view, a European country that has
38
39

Flash Economics, Economics Research, Natixis, 19, January, No 49. 2010.str.4.

Izvor: Economics Units, www.economics.com

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International journal of economics & law

Vol. 1 (2011), No. 1 (1-170)

maintained the highest level of gold reserves, while the UK recorded reduction. On the
other hand, Switzerland has recorded a significant decline in gold reserves. At the same
time, all BRIC countries recorded increase in foreign exchange reserves, excluding
Brazil. China leads the world in volume of increasing gold reserves in period 1994 2010. In addition, Russia has a growing trend in gold reserves.

GOLDENAGREEMENT OF CENTRAL BANKS

The ECB and fourteen central banks in 1999 signed the General Agreement on gold.
The agreement was later revised several times. However, when it was signed the first
time, the agreement had three objectives:40
- To regulate the sale of gold at a time when Belgium, the Netherlands, Austria,
Switzerland, and the United Kingdom sold or planned to sell gold;
- To avoid any anxieties that may lead to uncoordinated sales of gold (the price of gold
in 1980 amounted to USD 850 while in 1999 this price was U.S. $ 255);
- To prevent the drop in prices and destabilization of those economies that depends on
the
gold,
such
as
South
Africa.
Central banks of countries that in 1999 signed this agreement were ECB, Portugal,
Spain, France, Belgium, Luxembourg, Germany, Italy, Switzerland, Austria, England,
Ireland, Sweden, and Finland. In 2004, the agreement was signed by Greece. In 2009,
the agreement was signed by Cyprus, Malta, Slovenia, and Slovakia.

RESUME
Great world crisis that is current for a long time resulted in strong growth in gold prices.
Today, gold recorded high prices. Whether this trend continues in the future, largely
depends on the crises in the world. In line with previous analysis, we can state the
following:
- Although the gold in today's monetary system has a particularly important role, as was
the case in the system of Bretton Woods, it reveals similar movement on the issue of
trading gold between BRIC countries today and the countries of Western Europe in the
period after World War II. In fact, after World War II Western European countries
actively working to increase its gold reserves, aimed at strengthening the credibility of
its currency and strengthening the balance sheet position - this policy now implemented
BRIC countries with the same goal. Among these countries, especially the strong
growth of gold reserves recorded China. In addition, the current position of this country,
the second strongest world economy, has a significant impact on global economic
trends;
- Central banks that accumulate the highest levels of gold reserves are the Fed, the
Central Bank of Italy, the Central Bank of Switzerland, the Central Bank of France, and
the Bundes bank. The smallest gold reserves have Central Bank of Japan, the Bank of

40

Huffman, Gregory W., and Mark A. Wynne. The Role of Intratemporal Adjustment Costs in a
Multisector Economy Journal of Monetary Economics 43 (1999), 317.

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England, and the Central Bank of China, and India that recently rapidly increased its
gold reserves;
- It is important to note that, in addition that gold foreign currency reserves are recorded
at the central bank of each country, which are covered by this survey, the key decisions
on transactions in gold brings country. Therefore, it can be said that the managing gold
reserves of a country depends directly on the legitimate government and its policies. The
bigger is independence of the central bank, the greater is tensions between central banks
and government regarding the adoption of management gold policies;
- In the case of the Eurosystem, a revenue gain by the sale of gold shall be transferred to
that central bank which is involved in the transaction. The ECB is during the
formulation of the initial capital define that in overall structure of the initial capital gold
must have a minimum 15% share. It is not defined whether this share of gold will
change later.

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Acin,.,Meunarodni ekonomski odnosi, Pigmalion, Novi Sad, 2003;

Bordo, D., M. ,Dittmar,R.,Gold, Fiat Money and Price Stability, National
Bureau of Economic Research, Cambridge, 2003. Huffman, Gregory W., and
Mark A. Wynne: The Role of Intratemporal Adjustment Costs in a Multisector
Economy Journal of Monetary Economics 43 (1999),
Barro, Robert J. "Money and the Price Level Under the Gold Standard,"
Economic Journal, 89 (1979),
Gavin, William T., and Finn E. Kydland. Endogenous Money Supply and the
Business Cycle, Review of Economic Dynamics Vol. 2, No. 2 (1999),
Goodfriend, Marvin. "Central Banking under the Gold Standard," Carnegie
Rochester Conference Series on Public Policy 29 (Spring 1988):
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Friedman, Milton and Anna Schwartz, A Monetary History of the United
States: 1867- 1960, Princeton University Press, Princeton, 1963.
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Internet sources:
www.gold.org/government_affairs/reserve
asset_management/central_bank_gold_agreements/
www.reuters.com
www.economics.com

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