What do Venezuela, Central Banks and You Have in Common?

Gold and silver have been two of our best-performing assets so far in 2016. Part of the reason for gold’s rise is the fact that central banks are stockpiling of the precious metal. As the world’s currencies become increasingly abstracted into little more than numbers in a computer, silly bank tricks, like negative interest rates, are sending ripples of concern through the global financial system. Couple that with a pair of well-executed multimillion dollar hacks of the apparently not-so-secure international banking money transfer system called SWIFT, and you have a formula for smaller central banks to start rethinking their asset strategy.

The problem is that smaller central banks don’t have the questionable luxury of being able to inflate their way out of a currency crisis. You don’t have to look any further than Venezuela to see that dynamic in action. With its currency reserves exhausted by low oil prices, businesses in the South American country have been unable to get hard currency to pay for raw materials. With no way to pay for supplies, many factories and plants have been forced to close. Their inflation is at 1,000%; the country is economically destitute and on the verge of collapse. Venezuela is what a country with no foreign currency reserves looks like.

Many such small countries, in order to pay bills on the international stage, really need to hold reserves of foreign currency, which usually means buying bonds like those from the U.S. Treasury. Yet more countries competing for U.S. bonds drives down interest rates, one of the reasons that our sovereign debt hasn’t crippled the federal budget. But by holding gold, central banks in smaller countries would be able to realize a better return on their money with a relatively low cost of storage. In fact, a small country doesn’t even need to build a secure facility to hold its gold reserves; it can store them at the New York Federal Reserve.

More importantly, while you and I can’t pay our bills with gold without first exchanging it for currency, central banks don’t have that limitation. Central banks don’t even have to pay out their gold, just the fact they have it gives creditors confidence the nation will be able to pay its bills in a crunch, and its currency can be trusted. Turns out there’s a lot of evidence that central banks are buying gold, and it’s no surprise that two of the largest economies on earth, China and the U.S., are holding huge quantities of gold. Russia has been playing catch-up and increasing its gold reserves significantly. Overall central banks are piling up gold as currency becomes less reliable as a reserve.

Smaller central banks following the largest economies in adding gold to their asset mix is generally seen as a good thing. Quantitative easing in Europe, plus the threat of Great Britain exiting the EU, make holding the euro a risk—and no one really trusts China’s yuan. That leaves the dollar and, once again, too many countries bidding down the yield on t-bills. Some central banks have policies in place to prevent too many of their reserve assets being in one currency – enforced diversification, if you will. That leaves gold as the only safe, internationally respected option. The bonus with gold is that no one can hack it and no one can game the gold exchange system.

The takeaway for small investors, and even more crucially, those of us saving for retirement, particularly through a gold IRA? The world’s biggest experts on currency and monetary policy still rely upon the yellow metal as a crucial store of value and hedge against shock international devaluations of paper currency.