LONDON, Aug. 13, 2019 /PRNewswire/ -- There is increased uncertainty surrounding Italian gold holdings, with the Italian government examining ways it could support its ailing economy. In this Insight, we review how gold became central to the banking system, review historical actions and agreements between central banks and weigh what Italian gold sales would mean for the market.
Gold was at the centre of the banking system, based on fractional reserve banking and banknote issuance, when it emerged in the 17th century. Merchants concerned about the physical safety of their growing wealth began to store their gold with the goldsmiths for a fee. Soon after, gold became a bedrock for a new monetary system known as 'the gold standard'. By early 20th century, most developed nations linked their currency's value directly to gold. Central banks were responsible for maintaining that link and managing bullion reserves on behalf of their respective nations.
The outbreak of the World War I marked the beginning of the end of the gold standard, which ceased to exist in 1971, and the era of fiat money began. The unshackled gold price initially rallied through to 1980, but then entered a 20-years long bear market. As a legacy of the gold standard, post-war period and Bretton Woods, a number of Western central banks and the IMF still have substantial holdings of gold as a proportion of their total reserves.
Central bank act to limit sales
Between the late 1980s and 2007, the official sector was an annual net seller of gold. Disposals, largely from European central banks, more than matched reserve additions from developing nations. These heavy sales played a major role in keeping the gold market subdued. In the late 1990's, the downward pressure on the gold price was so severe that Western central banks debated the idea of the Central Bank Gold Agreement (CBGA) to put a limit on annual gold sales and prevent their own gold holdings from rapid devaluation. The first such agreement was signed in 1999 and covered the five-year period up to 26 September 2004, and limited sales to 400 tonnes in any single year.
The agreement was renewed three more times. Unlike in the previous versions, CBGA-4, covering the period between 2014 and 2019, did not contain a cap on sales. The signatories deemed it unnecessary considering that selling activity dropped dramatically following the credit crunch and financial crisis of 2008, with central banks as a group switching to become net purchasers for the first time in many years.
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