Why do we have gold reserves?

Gold. For centuries, the most sought-after precious metal on Earth. In 2022, central banks purchased 1,136 tons of gold, worth approximately 70 billion dollars. This marks the largest increase since records began in the 1950s. Gold is especially popular among central banks in emerging markets, as it provides a stable foundation in times of economic turbulence.
But what exactly is the role of gold in our economy? After all, we haven’t used gold coins for payments in a long time.
In the podcast Toegevoegde Waarde by Het Financieel Dagblad, journalist Anna Dijkman discusses these topics with economist and journalist Mathijs Bouman, as well as economist Aerdt Houben, Director of Financial Markets at De Nederlandsche Bank (DNB) and professor at the University of Amsterdam (UvA).
 

 

Gold reserves

Gold was used as a medium of exchange for centuries and served as the foundation of many monetary systems. Although it no longer plays this role, we still maintain gold reserves. With great effort, we extract gold from the ground, transport it across the world, only to store it deep underground once again—safely in a vault.
In the past, we wrote an article about the billions in gold and cash that DNB secretly relocated. This portion of the Dutch gold reserves has been stored in a new vault since May 2023, which is not accessible to the press. The old vault is currently being converted into a museum.
The Netherlands owns a total of approximately 612.5 tons of gold. This gold is stored across four locations: about 31% in the Netherlands, 31% in New York at the Federal Reserve, 20% in Canada, and 18% in London.
 

 

The history of gold

Gold has a long history. In the 19th century, DNB began accumulating gold to reinforce trust in the currency—a system known as the gold standard. The money in circulation was backed by gold held at central banks. In other words, it was always possible to exchange banknotes for physical gold at the bank.
This gold standard lasted until 1936. After World War II, another monetary system was introduced with gold as its foundation: the Bretton Woods system. More than 40 countries agreed to fix their exchange rates to the U.S. dollar, which in turn could be exchanged for gold at a fixed price.
The guilder remained stable in relation to gold through its link to the dollar. When the Netherlands had trade surpluses, it received dollars; when it had deficits, it lost dollars. These surpluses and deficits were tied to international trade. Like other countries, the Netherlands exported more than it imported, resulting in a surplus. To compensate for this surplus, the Netherlands received dollars, which were then converted into gold. This is how the Netherlands became the owner of the gold stored at the Federal Reserve in New York—a reserve that remains there to this day.
However, this arrangement with trade partners was costly for the Americans. Losing more and more gold reserves became unsustainable, which is why President Nixon ended the Bretton Woods system in 1971.
 

Why does gold have value

One of the reasons central banks hold gold is that gold reserves retain their value. But why?
Aerdt Houben explains that gold has intrinsic value, unlike a dollar or euro. The intrinsic value of money refers to the worth of the material used to produce the coin or bar. For example, a two-euro coin does not have an intrinsic value of two euros—it costs approximately 14.25 cents to produce.
Gold is also a homogeneous product—its composition is more or less the same across all parts of the market. Lastly, gold is a highly liquid asset, as it can be bought and sold worldwide. For these reasons, Aerdt Houben explains that gold is a highly suitable commodity on which to base an exchange rate system.
 

Why do central banks buy gold?

Gold is attractive to central banks due to its historical role and the trust it has solidified over time. In the event that a new currency is ever introduced or another systemic risk arises, the public can have confidence in DNB, knowing that any form of money can be backed by an equivalent value in gold.
At the same time, during the 1970s, 80s, and 90s, we evaluated the amount of gold we owned and whether it was still proportionate. To what extent should you continue to insure yourself against these types of systemic risks?
Ultimately, it was decided to reduce the Dutch gold reserves to approximately the average level of the major gold-holding countries in Europe. Currently, the Netherlands ranks 7th worldwide in terms of gold reserves relative to GDP. About 4% of our GDP consists of gold reserves, a percentage similar to that of France, Germany, and Italy.
Anna Dijkman rightly raises the question of whether 4% is enough. In response, Aerdt Houben explains that if the financial system were to collapse, the value of gold—and therefore our gold reserves—would increase significantly. He therefore considers this percentage to be sufficient.
Finally, Aerdt Houben points out that experience shows a full coverage for potential systemic risks is not necessary. Full coverage is only required in a country where no other mechanisms exist to support confidence in central banks.
 

 

Why gold 

But why gold and not diamonds or another precious metal like platinum? Anna Dijkman wonders. Aerdt Houben explains that throughout history, many other systems have been tried. But what has become clear? You need a commodity that is sufficiently available, homogeneous, and has a limited supply growth. Gold mining, for example, is a difficult process, and the global gold supply increases by less than 2% per year.
 

Gold: value or no value?

The intrinsic value of gold is clearly measurable. Gold has value in itself. Its price is determined by supply and demand in the market. However, opinions differ on the underlying value of gold.
Economist and journalist Mathijs Bouman is critical of gold. He points out that, for many people, gold still holds a mythical status as something that preserves wealth and value. However, compared to its historical role—such as during the gold standard or when gold and silver coins were used for payments—its significance today is much smaller.
Mathijs Bouman calls gold an emotional store of value. He sees it as a product that may not be useful at the moment but could be in the future. For example, in the event of a financial catastrophe, people might seek alternative means of exchange—ones that retain value not just because they bear a government’s signature.
Still, he believes it would be wiser to store other resources instead—such as essential goods that could be traded with other countries for necessities in the event of an apocalypse.
Mathijs’s personal opinion is that both banks and individuals have various arguments for holding gold, but ultimately, these arguments boil down to one thing: fear of the future. For that reason, they choose to invest part or even all of their portfolio in gold.
He sees gold as a self-fulfilling prophecy and compares it to Bitcoin—the only reason it has value is that others believe it does. However, if Mathijs were president of De Nederlandsche Bank, he wouldn’t sell the Dutch gold reserves. But as an economist, he considers the Dutch gold reserves absurdly high, calling it a medieval relic with a painful history.
Despite this, investing in gold has delivered an average annual return of 9% over the past 20 years. This proves that, despite the counterarguments, gold has been an effective means of preserving purchasing power.
 

 
Disclaimer: The Silver Mountain does not provide investment advice, and this article should not be considered as such. Past performance is no guarantee of future results.