Why gold & Bitcoin will not be reserve currencies
After World War II, central banks around the world held over 70% of their assets in gold. By 2010, that number had dropped to just under 10%. However, in recent years, this trend has started to reverse. Central banks globally have been racing to buy more gold, and some are even considering adding Bitcoin to their reserves. If this trend continues, the prices of both gold and Bitcoin could skyrocket. But what does this mean for the U.S. dollar, which has been the dominant reserve currency since gold was abandoned?
This shift could have significant implications for global finance, potentially weakening the U.S. and its economic power. So, is this surge in gold and Bitcoin purchases just a temporary blip, or is it the beginning of a major trend? And if it’s a trend, how will it affect the price of these assets and the future role of the U.S. dollar?
To answer these questions, I took a deep dive into what central banks are looking for in reserve assets, and what research says about their actual buying patterns. I'll break down the important findings for you, without the jargon.
What Are Reserve Assets?
In the simplest terms, reserve assets are holdings that central banks use to defend the value of their own currency. This comes into play in two main situations. The first is defending the currency in times of crisis. For instance, when the value of the Japanese yen dropped last year, the Bank of Japan sold off billions of dollars in reserve assets to generate more demand for yen, thereby stabilizing its price.
The second reason central banks use reserves is to prevent currency depreciation from turning into a full-blown economic crisis. For example, during Mexico's 1994 tequila crisis, companies that had borrowed dollars faced significant troubles because the peso’s value dropped dramatically. This made it difficult for them to repay foreign debts.
Thus, central banks hold reserve assets to stabilize their own currencies and prevent economic crises. But they also use these reserves for currency control, or as some might say, currency manipulation. For example, Hong Kong's monetary authority pegs the Hong Kong dollar to the U.S. dollar by buying and selling reserve assets as needed.
Why Is the U.S. Dollar the Best Reserve Asset Right Now?
To understand why central banks still prefer the U.S. dollar, let’s look at a global study conducted by the World Bank. They surveyed 191 central banks to find out what they value in a reserve asset. According to this research, central banks prioritize three things when selecting a reserve asset: safety, liquidity, and profitability.
Let’s go through each of these factors for different types of assets, like the U.S. dollar, gold, Bitcoin, and other fiat currencies.
- Making Money
The least important factor for central banks is profitability. U.S. government debt, for instance, yields an interest rate of around 4.4%, while similar bonds from Europe and China yield 2.5% and 1.7%, respectively. On the other hand, gold doesn’t earn interest—it actually costs money to store, which is a negative return of about 0.5%. Bitcoin, as a data entry, doesn’t pay any interest either.
While the dollar wins in terms of guaranteed returns, gold and Bitcoin often experience price increases over time, which could provide central banks with higher returns. In fact, the governor of the Czech central bank even suggested buying Bitcoin as part of the country’s reserves due to its potential for future gains. However, the volatility of Bitcoin and gold means that these assets are not guaranteed to perform consistently.
- Liquidity
The second priority is liquidity, which means how easily an asset can be bought or sold without affecting its price. Here, Bitcoin falls short for central banks. If they needed to sell large amounts of Bitcoin to defend their currency, it would likely crash the market. This is less of a concern for gold or the Chinese renminbi, and it's virtually nonexistent for the U.S. dollar, which is traded on the U.S. financial markets—some of the largest and most liquid markets in the world.
Moreover, liquidity also refers to how easily an asset can be accumulated. Unlike fiat currencies, which governments can print in large quantities, the supply of gold and Bitcoin is limited. This can make them more expensive to acquire, especially for central banks in poorer countries. Meanwhile, the U.S. dollar remains easy to obtain, as many countries accumulate it through exports to the U.S.
- Safety
Finally, safety is the most important factor for central banks. Safety refers to price stability or volatility. Both gold and Bitcoin have relatively fixed supplies, which can cause significant price volatility. Gold has historically been quite volatile, and Bitcoin is even more volatile. For example, Bitcoin experienced over 50% inflation in 2022, though it later experienced a deflationary phase in 2023.
Central bankers need stability, especially in times of crisis. A volatile asset like Bitcoin is unacceptable for them because it would make it harder to defend their currency when needed most. While Bitcoin enthusiasts argue that as Bitcoin gains acceptance, its volatility will decrease, the reality is that gold has remained volatile even when it was the world’s reserve currency. Bitcoin, with its restricted supply, is likely to remain more volatile than gold, which can still be mined if prices rise.
Additionally, there is the issue of safety in terms of physical security. During the Cold War, countries preferred to store their gold reserves in places like London or New York to protect them from possible invasion. While Bitcoin is secure in theory, many people have lost access to their Bitcoin due to hacking or lost passwords. This makes it less physically safe than the U.S. dollar, which central banks trust to be held securely in U.S. financial institutions.
Why Are Central Banks Buying Gold Again?
So, what has changed recently? Why are central banks suddenly increasing their gold reserves? One reason is sanctions. Researchers at the IMF found that when countries face sanctions from the U.S., UK, or the European Union, they often turn to gold as a safer asset. For example, Russia’s central bank has shifted to gold and other "friendly" fiat currencies after facing sanctions and the potential freezing of its U.S. dollar reserves.
While gold offers security, it still has significant downsides. It’s expensive to store, and it’s difficult to sell in global financial markets, especially if you want to avoid the U.S. or the West. This is where Bitcoin could play a role. Unlike gold, Bitcoin is digital, and while it may be slow and expensive to transfer, it’s still cheaper and easier to move across borders in large quantities than physical gold.
However, Bitcoin is still too volatile and lacks the liquidity required by central banks. That’s why, for now, countries like Russia have turned to the renminbi and the rupee rather than gold or Bitcoin.
What About the Future?
So, will central banks continue buying gold and even Bitcoin in the future? If they do, will it drive up the prices of both assets? While it’s unlikely that Bitcoin or gold will completely replace the U.S. dollar anytime soon, we might see gold continue to rise in importance, especially as countries look for alternatives to the U.S. dollar due to geopolitical tensions.
Bitcoin could earn itself a small place in central bank portfolios as a digital alternative to gold, but for now, its volatility and liquidity issues make it an unlikely candidate to become a major reserve currency. The U.S. dollar is still far ahead in terms of liquidity and safety, and its dominance isn’t likely to change anytime soon.
However, the rise of cryptocurrencies and the interest from institutional investors suggest that digital assets will continue to play an important role in the future of global finance. So while gold and Bitcoin may not become reserve currencies in the traditional sense, their role in the global economy will likely continue to evolve.