The gold price has soared by a third since the end of 2023, approaching a record $2,750 per ounce. The main driver of growth was purchases of the precious metal by central banks. The share of gold in their assets rose to 11 per cent from 6 per cent in 2008, The Economist reports.
This shift has important implications for America’s dominance in the global financial system. Even if the dollar remains the world’s undisputed reserve currency, its power is diminishing.
Dependence on the dollar became dangerous when the US and its allies froze $280bn of Russian sovereign assets and cut off Russian banks from SWIFT in the wake of the conflict in Ukraine. The transfer of assets from dollars to gold became a defence against potential economic wars for the world’s central banks.
Hence the search for a sanctions-proof alternative to the dollar. Some central banks are buying physical bars of gold and trying to move 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 their own currencies. According to the Federal Reserve, the share of Chinese goods billed in yuan has risen to a quarter from one-tenth in 2020.
Officials from Brazil, Russia, India, China and South Africa, who met this week at the BRICS summit in Kazan, are working to create a new set of cross-border payment rails that would bypass the dollar-based correspondent-banking system that dominates today.
A few years ago, the idea that central banks would be able to issue tokens and use them 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 developed such a system, and it is ready to go live. The BIS payment mechanism was not designed for the BRICS, but it could serve as a template for the new system.
BRICS impact on the dollar
What does all this mean for the mighty dollar? Ever since China emerged as an economic powerhouse, there have been fears that the dollar would be pushed out of the market as a reserve currency, just as it displaced sterling a century ago. But one need only look at the actions of central banks over the past few years to realise that there is no second choice reserve currency.
Central banks worried about sanctions are turning to gold, not the yuan. Instead of coming up with a whole new payments system, the BRICS countries could have simply agreed to use one of their currencies to trade among themselves. But they haven’t. Chinese manufacturers can invoice in yuan, but bilateral trade between Brazil and India will not be conducted through Beijing.
Therefore, the dollar will not be displaced from its position as the world’s reserve currency. The technology may be ready, but implementing new cross-border payment rails requires a degree of co-operation and trust among the BRICS countries that may not yet exist. Even if it does, many of the dollar’s privileges – higher purchasing power, lower yields – will remain.
Nevertheless, the power vested in 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 and more countries settle their accounts without the US banking system, sanctions will become less and less effective.
