The Banks' Mad Rush to Buy Gold: Should Small Businesses Follow?

The “de-dollarization” of the global economy has begun, and gold could be the best bet to hedge against this risk.

2022 was a wild year in the markets and 2023 is looking like it is going to be even more intense, to say the least. Inflation has and is surging, tech stocks have plunged and don’t look like they are going to recover anytime soon. Crypto is experiencing an epic wipeout and Russia destabilizing the world with its war in Ukraine is not helping (written with intended understatement)

All of this coming in the wake of several years of pandemic-induced uncertainty means many business owners are looking for new investment strategies, and – maybe even more so -- safe havens for their wealth.

So here’s what will hopefully be a useful observation: There may never have been a better time for small businesses to invest in gold.

But to understand why, we need to look at what’s happening today with money.

What’s Behind The Central Bank’s Gold Rush ?

Some of the most influential people in the financial world are betting that gold will keep going up – namely, central banks. For many years prior to the Great Financial Crisis, the Federal Reserve and other central banks had been selling their gold reserves, but over the past decade or so, they have become net buyers.

This process is accelerating. In 2022, central banks increased their purchases of gold by 28%, reaching the fastest pace since 1967, when the world was still on the gold standard. It's no coincidence this is happening at the very moment that inflation around the developed world has accelerated. After all, as we just mentioned, gold is an excellent hedge against inflation, and it turns out central banks need protection from a devaluing currency too.

Right now, the world’s central banks – some of them for the first time ever – are facing the prospect of multi-billion-dollar losses on their books.

The massive spike in interest rates in 2022 means central banks are now paying higher interest to their depositors (other banks) than they’re earning from their asset portfolios (mostly those government bonds they bought up during the 2008 financial crisis and the 2020 pandemic). The U.S. Federal Reserve and the Bank of England are both forecasting tens of billions in losses in the coming year.

When central banks rack up losses, depending on the country, they either have the gap covered by taxpayer money from the government treasury, or they turn those losses into a “deferred asset” that they write off once they stop losing money.

In other words, it’s an accounting gimmick that allows the central bank to hold off on recording its losses until it has the money needed to cover them. (Other banks and businesses can only wish they had it this easy. Turn your debt into an “asset,” and presto – you’re good!)

But if a central bank were to find itself in a very deep hole, one that you can’t just turn into a “deferred asset” without shaking confidence in your currency, then a central bank’s gold reserves can become a “nuclear option” – the banks can cover those debts by revaluing their gold to current market prices.

Much of the gold held by central banks was bought years ago, at lower prices than today’s. A good chunk was bought back in the day for $35 an ounce. If central banks were to use “mark to market” accounting rules and reassess the value of that gold at today’s prices, they would suddenly have a massive amount of equity to cover their losses.

The fact that central banks are buying gold at a frenzied pace suggests – maybe – that they are growing worried about just such a crisis, and about the potential decline of the dollar as a reserve currency.

Russia, China and ‘de-dollarization’

And just this year, Russian President Vladimir Putin’s invasion of Ukraine triggered a chain reaction of events that seems to have accelerated the dollar’s decline.

With Russian money and assets frozen in Western accounts, and Russian banks unable to transfer money internationally, the Central Bank of Russia had to act quickly to keep the country’s economy from collapsing.

In April 2022, it announced a policy that was largely overlooked in the mass media but sent shockwaves through the financial market. First, Russia’s central bank announced it would now be buying gold at a fixed price of 5,000 rubles per gram. Then, the boom was lowered: The finance ministry announced buyers of Russian oil would need to pay in rubles. In effect, Russia created a partial peg between its currency and gold using its oil exports as the mechanism.

This didn’t last long; the CBR ended its 5,000-ruble peg to gold within a month. But the move seems to have had the desired effect. After plummeting following Putin’s invasion of Ukraine, the Russian ruble returned to its pre-war level. Russia managed to bring confidence back to its currency by linking it – however briefly, however technically – to gold.

But the more significant issue here may be the reaction of various world governments to the conflict between Russia and the West. Countries that were at odds with the West in the past were alarmed at how thoroughly the Biden administration was able to use the dollar’s dominance to shut down Russian foreign trade. It seems many world leaders resolved never to allow this to happen to themselves – and that means ending the dollar’s status as the global reserve currency.

This year, we saw governments around the world take concrete steps to “de-dollarize” their foreign trade, and the effort centers around oil.

Following the end of the gold standard in 1971, the Nixon administration managed to maintain the dollar’s dominance by convincing Saudi Arabia to sell oil only in U.S. dollars, in exchange for military support from the U.S. For 50 years, this maintained the dollar’s position – but that is now unraveling.

China is now buying oil from Russia in Chinese yuan, making the yuan a reserve currency in Russia. Just this month, Chinese President Xi Jinping called for more of the world’s energy trade to take place in yuan rather than dollars, and that’s an idea Saudi Arabia seems receptive to. And Russian officials said this summer that the BRICS countries – Brazil, Russia, India, China and South Africa – are working on a new global reserve currency, though how credible this claim is, is anyone’s guess.

A Post-Dollar World - Is That Even Possible?

Today, there’s no clear candidate for a replacement to the U.S. dollar as a reserve currency. Some experts argue China’s yuan is well positioned, but others argue the currency is far too manipulated by Beijing to work as a means of trade for the world as a whole. Others point to the fact that the Bank for International Settlements (BIS), the Swiss-based “central bank of central banks” is busy designing a central bank digital currency (CBDC), an idea that comes with its own promises and risks.

But one thing is becoming clear amidst all these changes: The U.S. dollar’s status is in decline. And for U.S. businesses, this could be bad news.

If a significant chunk of world trade moves away from the dollar and towards any other currency, demand for that currency will soar and demand for the dollar will drop. The U.S. could see a massive decline in the value of the dollar, pushing up the cost of everything bought on the global market – i.e., almost everything. Inflation would worsen in the U.S., and consumers and businesses would find themselves permanently worse off under the new, weaker dollar. For U.S. businesses, this would mean higher costs and lower sales.

So how can you defend against this?

As a business owner, there’s little you can do about the geopolitical situation causing the dollar’s decline. But you can hedge against that decline, by building a gold reserve.

Consider what your cash reserves are making in savings accounts. The best business accounts out there today will pay you 2.5% to 3.5%. But inflation has been running above 8%, meaning those accounts are losing upwards of 5% annually to inflation. Especially in these circumstances, moving longer-term savings to something that earns more makes sense.

But be prepared for greater instability if you buy gold. It’s a hedge against inflation in the long run, but not necessarily in the short run. Unlike a fixed interest payment, returns on gold can be volatile. Gold is down about 0.5% over the past year – certainly no hedge against this year’s inflation.

Still, unlike many other investments, gold is fairly liquid – you can sell it almost anytime, meaning it’s almost as convenient as a savings account. And a gold portfolio will help with your company’s valuation – what investor doesn’t like to see a business with a large cushion of gold in reserve?

Testifying before Congress in 1912, investment banker J.P. Morgan famously declared, “Gold is money. Everything else is credit.”

It’s been a long time since the financial world has looked at things that way. But with the world awash in freshly printed cash, inflation at multi-decade highs, and government and consumer debt levels hitting record levels, maybe it’s time to start.

Central banks are taking the possibility of a currency crisis seriously. Business owners should as well. You may want to follow in the footsteps of the world’s most influential financial institutions, and jump into gold because one thing is most certain, the advent of serious AI advances, quantum computing and the numerous skirmishes waiting to explode into a full blown horror show around the globe by dictators crazy enough to use nuclear weapons, 2023 is going to be a roller coaster.

Resources

Bank for International Settlements

Federal Reserve Board

Bretton Woods explainer

A history of reserve currencies

Historical gold prices

Sources

https://www.macrotrends.net/1333/historical-gold-prices-100-year-chart

https://www.midasgoldgroup.com/news/world-reserve-currencies-since-1450/

https://www.brookings.edu/blog/up-front/2022/06/01/what-if-the-federal-reserve-books-losses-because-of-its-quantitative-easing/

https://smallbusinessbonfire.com/how-gold-investments-can-support-your-small-business/

https://www.contractorcalculator.co.uk/investing_your_company_money_gold.aspx