The blistering rally in gold does not bode well for the power of the dollar

Not so long ago, gold seemed to have lost its luster. In the decades after President Richard Nixon abandoned the gold standard in 1971, the yellow metal fell out of favor with central banks, which instead hoarded their reserves in dollars. In the 1980s and 1990s, investors and households grew tired of meager returns. Goldbugs were dismissed as eccentric doomsayers. Gold was attractive when forged into a shiny trinket and useful in specialist production, but it was hardly a serious financial asset.

How it shines now. The price has risen by a third since the end of 2023 and has reached an all-time high of almost $2,750 per troy ounce. The rush has been fueled by war, inflation and fiscal profligacy around the world, which have attracted family offices and Costco shoppers.

Yet perhaps no buyer has been as voracious as the world’s central banks, which have sucked up hundreds of tons of the stuff over the past two years. Gold now makes up 11% of their reserves, up from 6% in 2008. This shift has major implications for America’s dominance of the global financial system. Even as the dollar remains unchallenged as the world’s reserve currency, its power is waning.

For some central banks, interest in gold reflects concerns about the state of the world. Others have a smaller concern: that their dependence on the dollar, always uncomfortable and annoying, has become dangerous. Buying activity in China, India and Turkey was enthusiastic, and started to pick up again in the spring of 2022, after Russia invaded Ukraine and America and its allies tried to financially cripple Russia through sanctions. These include freezing about $280 billion in state assets abroad, and swiftly shutting down Russian banks, an interbank messaging service crucial for making cross-border payments. Visa and Mastercard, American companies that process debit and credit card transactions in almost every country in the world, also withdrew from Russia.

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

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

What does this all mean for the mighty dollar? Since China emerged as an economic force, concerns have arisen that the dollar would be displaced as a reserve currency, just as it itself displaced sterling a century ago. But you only have to look at the actions of central bankers in recent years to see that there is no second reserve currency. Central banks worried about sanctions turn to gold, not the yuan. Instead of inventing an entirely new payment system, the brics could have simply agreed to use one of their currencies for trade among themselves. They didn’t do that. Chinese manufacturers may invoice in yuan, but bilateral trade between Brazil and India will not go through Beijing.

The dollar will therefore not be ousted as the world’s reserve currency. The technology may be ready, but scaling new cross-border payment rails will require a level of cooperation and trust between the BRICS that may not yet exist. Even if that were the case, many of the dollar’s privileges—greater purchasing power, lower returns—would remain.

Nevertheless, the power given to the dollar by its status as a reserve currency is declining. Central banks’ reserves of physical gold are beyond Uncle Sam’s reach. As more countries settle a greater portion of their transactions without going through the U.S. banking system, sanctions will become less effective.

Clarification note (October 25, 2024): An earlier version of this article stated that the BIS payment system was ready to be deployed. It is used for live transactions, but to become operational, participants would have to agree to its launch.

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