Gold reserve is the amount of bullion that is held by the central bank or the treasury of the country. It contributes to the nation’s creditworthiness in the issuance of currency and bonds. Gold reserve that is held by the government should be distinguished from private hoard of goal held by individuals or non-financial institutions.
The concept of holding gold reserves started more than a century ago. Countries then strictly adhered to a practice known as the gold standard.
The Gold Standard
In the past, governments around the world committed to the gold standard. Basically, the price of domestic currencies will be fixed to a specified amount of gold. National money including notes and bank deposits can be converted to gold at a fixed price. The United States switched to the gold standard in 1900 when Congress passed the Gold Standard Act.
In the US, the price of gold was at $20.67/ounce in 1834, it stayed that way until 1933. The period of 1880 to 1914 is a time of unprecedented growth, opportunities, and free trade in terms of goods, capital, and labor. However, the gold standard broke down during the First World War because some countries used inflationary finance.
The system was briefly restored and countries were asked to retain a certain amount of gold and foreign currency (the US dollar and British pound). But this system did not work because Britain departed from gold following massive capital and gold outflows. Further modifications were made to the gold standard. Between 1946 and 1971, most countries settled their balances in US dollars.
Meanwhile, the United States would redeem other central banks’ holdings of dollars for gold at a fixed rate. US balance-of-payment deficits reduced gold reserves held by the country, which reduced confidence in the US’s ability to redeem currencies in gold. In 1971, I was finally decided that the United States can no longer redeem currency for gold. The gold standard was abandoned.
While the last vestiges of the gold standard disappeared in 1971, its appeal remains. It should also be noted that most countries, whether developed or developing, still hold significant amounts of gold to prove their creditworthiness. The United States has the highest amount of total reserves, followed by Germany and the IMF respectively.Back