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Central Banks and 'Reserves'
by Professor von Braun

August 8th, 2005

"If the American people ever allow banks to control the issuance of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property, until their children will wake up homeless on the continent their fathers occupied. The issuing of money should be taken from the banks and restored to Congress and the people to whom it belongs." -- Thomas Jefferson.

What exactly are central bank reserves? Not too long ago the answer would have been gold or a combination of gold and silver. Today it's different, so we are told, and the dominant reserve held by the central banks of the world are US dollars, which are estimated to comprise 70% of CB's total reserves, the balance being some gold and other paper currencies such as the Euro, the Yen and the Swiss franc. There are also other regional based currencies that make up a small portion of these reserves.

The Bretton Woods accord in July 1944 resulted in the US dollar becoming the agreed reserve to be held by other central banks because it was convertible into gold -- the US having at that time the largest actual gold reserve of any nation.

Other central banks could convert US $'s into gold by presenting their dollars to the US authorities and receiving gold at the rate of $35 per ounce. The idea was that when you held dollars, you held a gold equivalent as a reserve.

Webster's dictionary defines reserves (used in a financial sense) as:
1. money or its equivalent kept in hand or set apart usually to meet a specified liability or anticipated liabilities,
2. the liquid resources (such as gold and foreign exchanges) of a nation for meeting international payments.

This system worked fine for the next twelve or so years, but as the US continued to increase deficit spending, other central banks, the French in particular, started to redeem their hard-earned trade dollars for gold. The US gold supply was reduced considerably over the years. From 20312 tonnes in 1957, the US by 1971 had 9070 tonnes left. And as there seemed no end in sight to these redemptions, President Nixon on August 15, 1971 closed the Gold Window by refusing to allow the Treasury to further redeem any foreign-held dollars for gold.

From that date the concept of what a reserve actually was had changed dramatically. No longer could the dollar officially be redeemed for gold, however, it still remained the unit gold was priced in, and the metal could be purchased with dollars by any entity.

Financial markets were, over the next several years, in uncharted waters as the idea of sound money was left behind and the gold price increased accordingly as did interest rates on US Treasury bills. Gold responded to this new found 'freedom from a fixed price' by increasing 24-fold in price, peaking in early 1980 at $850 per ounce, up from $35. The decrease in the purchasing power of the dollar, one that had begun in the 1930's, also accelerated, which is perhaps why the gold price had increased.

Obviously these events were not what the central bankers wanted to see. The need for reducing both the gold price and high interest rates was now urgent and I suspect that some sort of 'secret' agreement, one not dissimilar to the 1961 Gold Pool plan, was reached by the Federal Reserve in consultation with other central banks and the IMF to start working on lowering the gold price to a more manageable level. By manageable level, I mean one that did not reflect a distrust in the currency itself. The price of gold is the only real critic of fiat currency there is, which is why central bankers do not like gold.

Having become unchained in 1971, the 24-fold increase that resulted was the reverse mechanism of the creation of credit in the sense that the private ownership of gold enabled one to increase ones supply of dollars, something the bankers believed they had a monopoly over. Obviously this could not be allowed to continue.

History is riddled with examples of currencies being debased, usually to pay off somebody's debts, the 'somebody' being the ruler of the day. Periods of financial stability have always been accompanied by a gold standard, by a coin of a known weight, and when debasement begins it tends to signal the end of peace and prosperity.

Perhaps this is what Thomas Jefferson was referring to when he spoke the remarks printed above, which references the formation of the First Bank of the United States.

Since January of 1980 the price of gold has declined and the number of paper contracts written has increased. However, the low of $255 per ounce in April of 2001 may well be the signal that the horse has once again escaped the corral and that a managed gold price is becoming increasingly difficult to maintain.

A substantial amount of Central Bank gold has over the years been sold to support either the fixed price period, an example being the UK which reduced its reserves by two-thirds from 1965 through to 1971, or as a result of the collusion to manage the gold price from 1980 on to today. Sellers have included Australia, Canada, the UK (again), Switzerland and other European banks, along with some lesser entities. At some stage the ability to manage the price via the use of paper contracts will become impossible to do as demand for physical metal exceeds Central Bankers ability to supply it.

Which brings us back to the question as to what exactly are central bank reserves in this day and age? In most cases (70%) they are US dollars, which originally were redeemable for gold, but now have no redeemable value other than other people's desire to hold them.

The US currently is dependant upon its trading partners to finance its deficits and continue to hold these units which in turn are classified by these 'partners' as 'reserves'.

Recently, China has been told by the US Congress that it can't spend its reserves as it sees fit. The anti-China stance, when it came to the proposed acquisition by China of Unocal, is only the beginnings of a movement that can only affect the US itself, since it brings into doubt the very idea of the US dollar being the world's reserve currency. This privileged position has been impaired since 1971, and has been abused on an ever increasing basis by the issuing of debt, partially enabled by a willingness of other central bankers to continue to accumulate ever more of these non redeemable instruments.

For Congress to tell a large holder of these peculiar instruments that they can not even redeem them by buying assets priced in US dollars is tantamount to saying "yes, you have the money, but, no, you cannot spend it." Now what sort of a reserve is that?

Should China be concerned about what it called 'undue political pressure?' One would think so. And would not a signal be sent to the Chinese to say 'OK, let's buy something else!' But what?

Much talk is heard about diversification by central banks but as the US has the monopoly on central bank reserves, what exactly could other central banks diversify into? They have to find somebody else to be willing to buy or exchange their dollars first and that's the tricky part when it comes to the actuality of diversification.

Are they holding reserves in the true sense of the word, or are they merely holding liabilities that are uncollectible, unenforceable and unredeemable at that? And is this not what Thomas Jefferson was referring to all those years ago, failing only to estimate the size of the potential fallout by not including other countries as well?

The Prof can be contacted by email at

Copyright by Professor von Braun. All Rights Reserved. Reprinted at USAGOLD by permission.

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The Rocket School of Economics -- The Lecture Series Index

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  • 14 Nov 2008 -- What Exactly is an Asset?
  • 23 Aug 2008 -- Through the Looking Glass?
  • 02 Aug 2008 -- Compounding to the Downside!
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  • 10 Dec 2007 -- Monetary Systems & Productive Assets.
  • 14 Feb 2007 -- Divorced from Reality
  • 06 Sep 2006 -- Gold, Bankers, the Trade Deficit and Unsettled Transactions
  • 19 Jun 2006 -- When is a Reserve Not a Reserve?
  • 31 May 2006 -- The significance of August 15, 1971.
  • 08 Apr 2006 -- Keep Your Eye on the Ball!
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  • 11 Dec 2005 -- Gorillas, Rising Gold Prices and Depreciating Paper Currencies!
  • 23 Oct 2005 -- Custodial Risk.
  • 16 Sep 2005 -- An Inherent Flaw.
  • 08 Aug 2005 -- Central Banks and 'Reserves'.
  • 31 Jul 2005 -- Central Bankers, Actors and 'We'.
  • 17 Jul 2005 -- Unintended Consequences! -- Part 3.
  • 07 Jul 2005 -- Unintended Consequences! -- Part 2.
  • 25 Jun 2005 -- Unintended Consequences! -- Part 1.
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  • 03 Jun 2005 -- Real Money, Funny Money and YOU -- Part 4.
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