Does China’s ‘nonstop’ gold purchase show shift away from US dollar?

China’s central bank is ramping up its gold reserves. In fact, it’s spearheading the “record levels of central bank purchases” of gold worldwide.

The People’s Bank of China (PBoC) purchased a total of 225 tons of the precious metal in 2023, lifting its gold reserves to 2,235 tons, according to the latest data released by the World Gold Council (WGC).

So why is the world’s second largest economy stocking up on something that does not bear any interest and is far more difficult to use in actual transactions than the highly liquid US dollar-denominated securities preferred by most nations?

“It is true that the PBoC’s gold holdings rose significantly in 2023. One possible reason could be the increased economic and financial uncertainty and geopolitical tension,” says Louis Kuijs, chief economist for Asia Pacific at S&P Global Ratings, while speaking to TRT World.

“It is in principle possible that China would especially like to reduce its reliance on dollar-denominated reserves, given the increase in tension with the United States,” he says.

China has been trying to replace the US dollar with the renminbi as the main international reserve currency for years. The issuer of a reserve currency enjoys distinct financial clout globally as it can ease or limit others’ access to liquidity. Greater demand from central banks around the world also means the reserve currency-issuer can easily finance its deficits without forcing austerity on its population.

The reserves conundrum

Most countries prefer to hold the largest part of their foreign exchange reserves in the US currency. That’s because it’s most liquid and backed by the US government. A stash of ready-to-use, as-good-as-cash securities means a country can ride out an economic downturn when its foreign exchange reserves are running low.

In contrast, low levels of foreign exchange reserves mean limited liquidity in an economic crisis. A lack of dollars results in a country’s inability to meet financial obligations like import payments, creating conditions for a painful economic contraction.

Against that backdrop, one might ask why a country would choose to hold reserves in gold when its storage, transportation, and transaction costs are so obviously higher than the dollar-based instruments?

Keeping the entirety of foreign exchange reserves in US dollars can make a country vulnerable to the United States. A case in point is Russia, which has had its central bank reserves estimated to be between $300 billion and $415 billion blocked by US sanctions in response to Moscow's war on Ukraine.

One possible explanation for the rapid buildup of gold reserves by China is that the economic juggernaut is steering away from the dollar-denominated reserves to forestall a seizure of funds in a confrontation with the United States?

US dollar’s hegemony continues

A report in the Financial Times noted that China’s gold-buying spree is driven by a “desire to weaken” its dependence on the US dollar as a reserve currency after Washington “weaponised the greenback” in its sanctions against Russia. China has added more than 287 tons of gold to its stockpile in the last 14 months alone.

This view is reinforced by a survey of central banks conducted by the WGC last year, which showed their view of the US dollar’s future role is getting “more pessimistic”. By contrast, their view of gold’s future role has grown “more optimistic,” with six in every 10 central banks saying that gold will have a greater share of total reserves going forward.

Moreover, half of the central banks surveyed believed the percentage of reserves denominated in the US dollars in five years would be as high as 40-50 percent.

The global share of gold holdings in total reserves has seen little movement in the past two decades. It stood at 13.5 percent at the beginning of the century and has inched up to only 15.5 percent of the worldwide reserves.

But Kuijs believes that China will stick to the US dollar as the mainstay of its reserves in the foreseeable future. “It is, in my view, unlikely that China will try to replace a major share of its US dollar-denominated reserves with gold. Gold doesn’t have an inherent rate of return,” he says.

US dollar-based foreign exchange reserves of China amount to more than $3.2 trillion. Gold accounted for only 4.3 percent of China’s total reserves at the end of 2023. “That remains a modest proportion,” he says.