central banks

Anyone who reads financial headlines knows that gold prices have soared in the past year. Why?

Gold has historically been a relatively stable store of value, and that role seems to be returning after decades of relative neglect. Official numbers show sharply increased buying by the world’s central banks, led by China, Poland, and Azerbaijan in early 2025. Russia, India and Turkey have also been major buyers. There is widespread conviction that actual gold purchases are appreciably higher than the officially-reported numbers, to side-step President Trump’s threatened extra tariffs on nations seen as de-dollarizing.

I think the most proximate cause for the sharp run-up in gold prices in the past twelve months has been the profligate U.S. federal budget deficit, under both administrations. This is convincing key world actors that the dollar will become increasingly devalued over time, no matter which party is in power. Thus, it is prudent to get out of dollars and dollar-denominated assets like U.S. T-bonds.

Trump’s erratic and offensive policies and statements in 2025 have added to the desire to diversify away from U.S. assets. This is in addition to the alarm in non-Western countries over the impoundment of Russian dollar-related assets in connection with the ongoing Russian invasion of Ukraine. Also, there is something of a self-fulfilling momentum aspect to any asset: the more it goes up, the more it is expected to go up.

This informative chart of central bank gold net purchasing is courtesy of Weekend Investing:

Interestingly, central banks were net sellers in the 1990s and early 2000s; it was an era of robust economic growth, gold prices were stagnant or declining, and it seemed pointless to hold shiny metal bars when one could invest in financial assets with higher rates of return. The Global Financial Crisis of 2008-2009 apparently sobered up the world as to the fragility of financial assets, making solid metal bars look pretty good. Then, as noted, the Western reaction to the Russian attack on Ukraine spurred central bank buying gold, as this blog predicted back in March, 2022.

Private investors are also buying gold, for similar reasons as the central banks. Gold offers portfolio diversification as a clear alternative from all paper assets. In theory it should offer something of an inflation hedge, but its price does not always track with inflation or interest rates.

Here is how gold (using GLD fund as a proxy) has fared versus stocks (S&P 500 index) and intermediate term U. S. T-bonds (IEF fund) in the past year:

Gold is up by 40%, compared to 12.6% for stocks. That is huge outperformance. This was driven largely by the fact that gold rose strongly in the Feb-April timeframe, while stocks were collapsing.

Below we zoom out to look at the past ten years, and include the intermediate-term T-bond fund IEF:

Gold prices more than doubled from 2008 to 2011, then suffered a long, painful decline over the next two years. Prices were then fairly stagnant for the mid-2010s, rose significantly 2019-2020, then stagnated again until taking off in 2023. Stocks have been much more erratic. Most of the time stock returns were above gold, but the 2020 and 2024 plunges brought stocks down to rough parity with gold. Since about 2019, T-bonds have been pathetic; pity the poor investor who has been (according to traditional advice) 40% invested in investment-grade bonds.

How to invest in gold? Hard-core gold bugs want the actual coins (no-one can afford a full bullion bar) to rub between their fingers and keep in their own physical custody. You can buy coins from on-line dealers or local dealers. Coins are available from the U.S. Mint, but reportedly their mark-ups are often higher than on the secondary market.

An easier route for most folks is to buy into a gold-backed stock fund. The biggest is GLD, which has over $100 billion in assets. There has long been an undercurrent of suspicion among gold bugs that GLD’s gold is not reliably audited or that it is loaned out; they refer derisively to GLD as “paper gold” or gold derivatives. The fund itself claims that it never lends out its gold, and that its bars are held in the vaults of the custodian banks JPMorgan Chase Bank, N.A. and HSBC Bank plc, and are independently audited. The suspicious crowd favors funds like Sprott Physical Gold Trust, PHYS. PHYS is claimed to have a stronger legal claim on its physical gold than GLD. However, PHYS is a closed-end fund, which means it does not have a continuous creation process like GLD, an open-end ETF. This can lead to discrepancies between the fund’s share price and the value of its gold holdings. It does seem like PHYS loses about 1% per year relative to GLD.

Disclaimer: Nothing here should be taken as advice to buy or sell any security.

Finnish crisis researcher Tuomas Malinen has for some time been predicting the collapse of the Western financial system, starting with the melt-down of the European Central Bank. Malinen, an associate professor of economics at the University of Helsinki, offers his views on his substack and elsewhere. He correctly warned in early/mid 2021 of coming inflation, which would present central bankers with severe challenges.

Among other things, by raising interest rates (to counter inflation), the banks necessarily cause the value of bonds to drop. However, a lot of the assets of the central banks consist of medium and long term bonds, especially those issued by sovereign governments. We have come to the point where some central banks are technically insolvent: the current cash value of their liabilities exceed their assets.

Is that a problem? Most authors I found did not seem to think so. For a normal private bank, as soon as the word got out that it was insolvent, customers would rush to withdraw their funds, in a classic “run on the bank”. Customers who waited too late to panic would simply lose their money, since there would not be enough assets on the bank’s balance sheet to cover all withdrawals.

However, no one seems to be in a hurry to beat down the doors of the Fed and demand their money. Most of the liabilities of the Fed are (a) paper currency in circulation, and (b) “Reserve” accounts of major banks at the Fed.

Bandyopadhyay, et al. note that negative equity in central banks (including those of smaller countries) is not uncommon; at any given time, about one out of seven central banks worldwide in the 2014-2017 timeframe suffered operating losses, some of which were large enough to wipe out their capital. However, most central banks are owned by, or have some other synergistic relationship to , the governments of their respective countries. For instance, there is a standard contractual relationship between the Bank of England (BOE) and the British government. Thus, when the BOE recently fell into arrears, the government provided them with additional funds. This was apparently a routine non-event. (I don’t know where the government came up with those additional funds; did they just issue more bonds, which in turn were purchased by the BOE?)

The Fed, as a privately-owned public/private hybrid, technically has a more arms-length distancing from the U.S. Treasury. For instance, the Fed is not supposed to buy government bonds directly from the government. Rather, the government sells them to large banks, who in turn sell them to the Fed (if the Fed is buying). It is possible for the U.S. Treasury to transfer funds to the Fed to recapitalize it; but for now, the Fed is just booking losses as a “deferred asset”. Voila, the magic of central bank accounting. The presumption is that sometime in the future, the Fed will receive enough net income to overcome these losses.

The biggest debate is over the fate of the European Central Bank (ECB). Its relation to sovereign governments is even more arms-length; it is difficult to see all the European countries, with their own budget issues, agreeing to cough up money to give to ECB. As Malinen sees it, this likely leads to the “deferred asset” accounting scheme to handle negative equity for the ECB. He worries, “Will the markets or the banks trust the ECB after losses starts to mount forcing the Bank to operate with (large) negative equity? We simply do not know.” This is a weighty issue. As we noted earlier, “money” is in the end a social construct, an item of trust among parties for future payments of value. Central banks are the lenders of last resort, the source of money when it has dried up elsewhere; they regularly have to step into financial liquidity crises to inject more money to keep the system going. If people stopped accepted the keystroke-created money from central banks, the whole economy could freeze up.

A more sanguine view of central bank negative equity issues from MMT proponent Bill Mitchell. In his “Central banks can operate with negative equity forever” Mitchell heaps scorn on the very idea that central banks could run into solvency problems. He states that a “government bailout” is an inconsequential paper operation, merely transferring money from the left pocket to the right pocket of the government/central bank joint entity (as he views it). Furthermore, central banks have the capability of creating money out of thin air, so they can always meet their obligations and therefore can never be deemed insolvent:

The global press is full of stories lately about how central banks are taking big losses and risking solvency and then analysing the dire consequences of government bailouts of the said banks. All preposterous nonsense of course. It would be like daily news stories about the threat of ships falling off the edge of the earth. But then we know better than that. But in the economic commentariat there are plenty of flat earthers for sure. Some day, humanity (if it survives) will look back on this period and wonder how their predecessors could have been so ignorant of basic logic and facts. What a stupid bunch those 2022 humans really were.