Is Gold Signaling De-Dollarization Looms? No.

Lately, chatter has grown over more international trade being conducted in non-dollars, like the Chinese yuan and Indian rupee. We addressed all that here, so we won’t rehash it now. But some say this is only part of the story: Gold, they claim, offers a signal that the world’s chief reserve currency’s days are numbered, citing a chart and argument making the rounds. We think such theories are beyond a stretch. Let us show you.

The chart in question supposedly shows a breakdown in the inverse relationship between the 10-year Treasury Inflation-Protected Securities (TIPS) yield and gold—which some take as a sign the dollar is losing its reserve currency status. (Exhibit 1) Both theoretically attract money as inflation rises, presumably leading TIPS yields to fall (and prices to rise) as gold climbs—and vice versa when inflation fades. But over the last several months the link has supposedly weakened, with TIPS yields up almost three percentage points over the last year to levels last seen in 2010, while gold—though lower—remains near the high end of its range over this period.

Exhibit 1: Fun With Spurious Correlations, Part I

Source: FactSet, as of 4/4/2023. 10-year TIPS yield and gold price per troy ounce, 1/2/2007 – 4/3/2023.

To watchers, this alleged divergence suggests something is amiss. Many think gold possesses intrinsic value globally—while TIPS pay only in dollars. They conclude: In an apparent time of trouble, the world’s preference for safe-haven dollars has taken a hit. Coupled with Emerging Markets (EM) central banks’ record gold buying—and among the largest (e.g., Brazil, Russia, India, China and South Africa) reportedly forming their own reserve currency—pundits jump to the conclusion the dollar is losing its luster.^[i]

But not so fast. Zoom out a bit more and adjust the scales to reflect equivalent percentage point moves and the relationship isn’t as tight as initially portrayed. (Exhibit 2) For example, gold rallied from $411 per troy ounce in February 2005 to $725 in May 2006, while 10-year TIPS yield rose from 1.5% to 2.5%. The actual “breakdown” then was more severe than today.

Exhibit 2: Fun With Spurious Correlations, Part II

Source: FactSet, as of 4/4/2023. 10-year TIPS yield and gold price per troy ounce, 1/2/2003 – 4/3/2023.

While that is just one extreme example of divergence, the historical relationship actually isn’t very consistent. Consider: We calculated the monthly correlation between the change in TIPS yields (percentage points) and the percentage change in gold prices over the last 20 years. A correlation of 1.0 means the assets move in lockstep, and -1.0 means they are polar opposites. For the theory to hold, the two should usually be strongly negatively correlated—with today showing the opposite.

That isn’t the case, though. The correlation over the last 20 years is -0.45, showing a rather meh relationship between the two.^[ii] Over the 12 months ended in March, it is similarly meh, at -0.46. Exhibit 1, which purportedly shows a break from the norm, glosses over the actual directional volatility. In short, the relationship isn’t set in stone, past breaks haven’t hinted at dollar doom and there is little sign the present one, to the limited extent it even exists, does either.

Beyond this, some argue EM central banks have been buying lots of gold lately, suggesting a shift in preference from the dollar to a shiny yellow metal. But that preference isn’t necessarily portentous. Central banks don’t have a terribly great record of timing gold purchases, which no knock on them, few do. In the decade to 2010, for example, they were net sellers when gold tripled. As net buyers since 2010, gold has mostly moved sideways. We don’t think their buying signals anything about gold’s—or the dollar’s—longer-term direction. Meanwhile, their latest bout of buying just reverses a long-running trend away from gold, to only 7% of EM reserves in 2021 down from 30% in 1950.^[iii] Developed markets’ gold reserve share shrank to 17% in 2021 from 80% in 1950.

While there is so much chatter about the dollar losing its status, look at actual dollar-use data and you will find it is still very much in demand and widely held. There isn’t a great way to track how much world trade uses dollars, but the BIS estimates about half of trade globally is invoiced in dollars, despite America accounting for only around 10% of global trade.^[iv] Another way to see this is to use the dollar’s share of global currency reserves as a proxy for demand. IMF Currency Composition of Official Foreign Exchange Reserve data aren’t perfect, but the dollar’s share was 55.5% in Q3 2022 versus about 70% two decades ago. (Exhibit 3) Down, yes, but no one else comes close.^[v] Besides, the total amount of reserves is up a lot, so there are actually more dollars held in reserve than two decades ago, despite its falling share.

Exhibit 3: USD Still Dominates as Global Reserve Currency

Source: IMF, as of 4/4/2023. Percent of allocated reserves in US dollars, euros, Japanese yen, British pounds and Chinese yuan, 1995 – 2022.

Then too, in global finance, 88% of foreign exchange transactions (out of 200% given pairwise trading) use the dollar. (Exhibit 4) As the BIS states, it also dominates offshore funding markets: “As of the second quarter of 2022, the amount of debt and loans denominated in USD where neither the issuer/borrower nor the lender is a US resident is estimated to be 88% of total international USD-denominated debt and 65% of total international USD bank loans.”^[vi]

Exhibit 4: USD Still Dominates in Global Currency Trading

Source: BIS, as of 4/4/2023. Percent of global currency trading for US dollars, euros, Japanese yen, British pounds and Chinese yuan, 1989 – 2022. Note: Currency trading shares sum to 200% because currencies always trade in pairs.

Now, these dollar usage stats are all backward looking. They could change. But the chances that happens fast are exceedingly low. And even if the dollar’s reserve currency and trade status did dwindle, it probably wouldn’t be disastrous. As noted before, the UK didn’t implode after the dollar overtook the pound as coin of the realm over a century ago. Gilt yields are just a hair less than Treasurys’ today.^[vii] Exorbitant privilege doesn’t confer any advantage. So we doubt losing it would be a disadvantage, much less ruinous for America.

The dollar is convenient because of the US’s big economy—which produces goods and services consumed globally—with deep, liquid and open financial markets facilitating that trade. That is why dollars remain in demand. Those factors don’t look set to change any time soon.