Gold prices,India loves gold so much that it is the second largest consumer of gold in the world. Indians own more gold than the central banks of the United States, Germany, Italy, France, and Russia combined. While the US holds 8,100 tons of gold and Russia holds 2,332 tons, Indian consumers hold a whopping 21,000 tons of gold.
In the past six months, something surprising has happened in the markets.
While Sensex gave an 8.33% return and Nifty gave a 9.92% return, the price of gold went up by 16.16%. This is surprising because, in recent years, central banks worldwide have been buying a lot of gold. For example, India moved 100 tons of gold from England to India and bought 69 more tons. China bought 314 tons, Poland bought 130 tons in 2023, Singapore bought 125 tons, and even the Czech Republic bought 75 tons.
This trend shows that many countries are stacking up on gold, causing prices to reach high levels. So, why are central banks buying so much gold? What global factors are affecting gold prices right now? And should you, as an investor, consider investing in gold?
How Does Gold Impact the(Gold prices ) Global Economy?
Let’s start with why gold is so important in the world economy. This story goes back to the 1940s. By then, the world had seen World War I and was in the middle of World War II. The Treaty of Versailles had started World War II in 1939. The whole world was against Hitler, and it was the worst war in history.
At that time, the British Empire was a superpower with many colonies. But after fighting both World Wars, their wealth was almost gone. By the early 1940s, Britain’s debt-to-GDP ratio went from 25% in 1940 to 220% in 1920, and then to 270% in 1942. Other major countries like France and the Soviet Union were also struggling.
However, the United States played it smart. They first joined the wars as merchants, then as participants. America remained undamaged by the war and became very prosperous. It now dominated banking and trade worldwide. With more capital, better production, and new technology, American industry was ready to lead both domestic and global markets after the war. People said you could sell anything in America.
How Did the US Economy Flourish During World Wars?
When all the big empires were busy fighting in World War I, they used all their people and resources for the war. Meanwhile, the United States put its money and workers into becoming a major supplier of goods like cotton, wheat, brass, rubber, cars, machinery, and thousands of other items. They sold these goods to the richest countries around the world.
As a result, the US economy grew a lot. The total value of US exports went from $2.4 billion in 1930 to $6.2 billion in 1970. The same thing happened during World War II. The US became a big supplier again and only joined the war after Pearl Harbor.
While other countries’ economies were hurt by the wars, the United States made so much money that it ended up with 75% of the world’s monetary gold. Their gold reserves grew from about 2,000 tons in 1910 to almost 20,000 tons in 1940.
This is how the United States became very rich. In 1944, they used this opportunity to gather 44 countries to sign the Bretton Woods Agreement.
In the Bretton Woods Agreement, 44 countries agreed to link their currencies to the US dollar, which was tied to gold. But why did they sign this agreement, and what did they gain?
The agreement stated that the US would back its dollars with gold, setting the value at $35 for one ounce (28.35 grams). This meant if you had US dollars, you could exchange them for gold. For example, if Indonesia received 1 million dollars from Pakistan, even if Indonesia didn’t trust Pakistan, they knew they could trade those dollars for gold in the US.
This made the US dollar a trusted currency for trade. Without it, using something like the Pakistani rupee would be risky. Today, 1 rupee might buy a gram of gold, but tomorrow Pakistan could print more money and change that value. This would ruin the trade’s worth. Also, if Indonesia saved up Pakistani rupees and other countries didn’t trust Pakistan’s economy, those rupees would be useless for international trade.
The US dollar became a common and trusted currency worldwide because of this agreement. After Bretton Woods, trading with US dollars meant you could be sure of their value in gold.
The agreement also created two important organizations: the World Bank and the International Monetary Fund (IMF).
Many countries were destroyed by war and needed loans to rebuild their economies. With funding from the United States, the World Bank gave out large loans to help these countries recover. The IMF also played a key role. While the World Bank provided long-term development loans, the IMF monitored the global economy, helped policy makers, and lent money to countries with payment problems.
Countries like Pakistan and Sri Lanka turned to the IMF during economic crises. This support from the World Bank and IMF helped maintain the importance of the US dollar and gave the United States significant influence over other countries. This was the first step in establishing the dominance of the US dollar.
Oil and the US Dollar
Let’s talk about the US dollar’s connection to oil. This story goes back to World War II. While Russia, Britain, and the US were fighting Germany, Italy, and Japan, the Arabs in Saudi Arabia were not involved in the war. They didn’t know they were sitting on a huge oil reserve.
In the 1930s and 40s, US and British companies were searching for oil worldwide. They had the technology to extract it and knew how to use it for development. In 1938, an American-owned oil well in Saudi Arabia struck a massive oil source. This well produced mostly gas.
There was a lot of hard work. They drilled ten wells but found no oil. The first well mostly had gas. The second well had more water than oil. The third and fourth wells were almost dry. But then, I got a note saying we had discovered oil. This meant more wells, more workers coming to Dhafran, and the king visiting from Riyadh.
Back then, Saudi Arabia wasn’t rich because their oil production had just started. During the war, Italy bombed Saudi Arabia to hit American facilities. This made it hard for Saudi Arabia to produce oil at full capacity. They needed protection desperately.
Franklin Roosevelt, the US president at that time, saw massive development during the war and realized that oil was key to future growth. In 1945, he had an important meeting with the Saudi king and made a deal that changed everything.
The deal was simple: the United States would protect Saudi Arabia from future attacks and provide military equipment. In return, the Saudi king agreed to sell oil mainly in US dollars. The American-dug well turned out to be the largest oil well in the world. This marked the beginning of the Middle East’s rise.
By the 1960s, oil-producing countries formed OPEC and started selling oil in dollars. But why was selling oil in dollars such a big deal? How did this make the US dollar the most powerful currency in the world?
This is where the third phase of the rise of the US dollar comes in. It became known as the “dollar mafia.” Remember the Bretton Woods agreement? It said if you pegged your currency to the US dollar, America would redeem its value in gold.
But by the 1970s, the US economy was in bad shape. Gold reserves fell from 22,000 tonnes in 1950 to just 10,000 tonnes in 1970. This happened due to reasons like the Vietnam War, rising gold prices, and US liabilities.
The US couldn’t afford to keep exchanging gold for dollars anymore. So, President Richard Nixon declared a temporary suspension of the dollar’s convertibility into gold. The Bretton Woods system collapsed in 1973.
Shifting Currency Dynamics
Countries could choose any exchange arrangement for their currency, except linking it to the price of gold. Now, the value of a currency depends more on what it can buy in the global market and from which country. For example, the US dollar used to be able to buy oil, which was the most valuable commodity of the century.
Because of this, many countries held their foreign exchange reserves in US dollars to buy oil from Arab countries. Over time, other currencies like the Euro, Yen, and Yuan also became important in world trade.
At first, the US dollar was backed by gold. Then it was backed by oil. Now, it is supported by oil trade but not directly backed by any commodity. This is why countries hold their dollar reserves in US treasury bonds. For instance, Japan holds $1.1 trillion in US bonds, China holds $797 billion, and India holds $236 billion.
But now, countries are buying a lot of gold. Why? During the Russia-Ukraine war, the United States froze $300 billion of Russian assets stored in US dollars. Similarly, after the Taliban took over Afghanistan, the United States froze $7 billion of their reserves.
Global Shift in Currency Trust
After the Taliban took over Afghanistan, the United States froze $7 billion of their reserves. This made China worried in 2022. They feared the US could seize China’s $797 billion in US treasury bonds, which would be very bad for China. The US and China are in a trade war, and China wants to take over Taiwan.
After the Russia-Ukraine war, China started buying a lot of gold. Countries like the Czech Republic, Poland, and Singapore did the same. Poland is especially cautious because it is close to Ukraine.
This doesn’t mean all countries are giving up on the US dollar suddenly. But trust in the US dollar is slowly decreasing. It might take another 50 years for another currency to become the world’s main reserve currency. The US dollar’s market share has dropped from 75% in 1970 to 59% in 2022.
Gold prices are rising because the US froze Russian reserves, pushing other countries to buy gold. But why are India, China, and other countries moving away from the US dollar if they aren’t at war with the US?
The second reason is the United States’ habit of printing money recklessly. For example, they printed almost a trillion dollars in 2008 during a recession. They printed $4 trillion in 2020 and over $2 trillion in 2021. This massive money printing causes inflation around the world.
Gold vs. Dollar
When the value of the US dollar goes down, it affects what you can buy. For example, today $100 might buy you 25 burgers, but after inflation, it might only buy you 20 burgers.
Countries chose the US dollar as a reserve currency because they could exchange it for gold, preserving its value. They didn’t trust countries like Pakistan because Pakistan might print more money, causing their currency to drop in value.
But now, the US is printing money too, which decreases the value of other countries’ dollars. For example, if China has $3.2 trillion in reserves and the US prints more money, the value of China’s reserves will go down.
This is where gold becomes important. No one can print or make more gold, so its value stays stable. This is why countries are buying gold; they want to protect their reserves from losing value due to US dollar printing.
Gold is also very rare. All the gold in the world could fit into a 23 by 23 by 23 meter cube. Because gold is so limited, its value remains high.
Lastly, there is massive consumption of gold, which also keeps its value high.
Indian and Chinese consumers both have a strong interest in gold. In India, as people’s income grows, they buy more gold for festivals and to save money. This happens no matter what the market does.
China’s story is different. First, China is facing a real estate crash. The government encouraged building lots of houses, but now there are too many. This has caused the real estate market to fall. Second, the Chinese stock market isn’t doing well either. Over the past five years, the Shanghai index only grew by 5.87%. In contrast, India’s Sensex grew by 94.4%, and the S&P index grew by 85.2%.
Because of these issues, Chinese people are investing heavily in gold. Imagine buying a flat for 1 crore rupees, but after three years, it’s worth only 70 lakh rupees. Also, your stock portfolio only grew by 6% in five years. If both real estate and stocks are down, you’d likely invest in gold too.
Chinese gold consumption is huge. In one year, Indian consumers bought 774 tons of gold, while Chinese consumers bought 824 tons. Together, they bought more gold than the next ten countries combined. According to the World Gold Council, China’s gold consumption jumped from 641 tons in 2020 to 959 tons in 2023.
This high demand from India and China is one reason why gold prices are rising. Another reason is investor sentiment. Gold usually has a low or negative correlation with the stock market. When the stock market goes up, gold prices often go down and vice versa.