Here’s why Russia’s Central Bank is buying gold

Russia’s Central Bank has been continuing with its gold buying strategy, which has been ongoing now for several years.

When Putin became President the gold stockpile held by Russia’s Central Bank amounted to just 343 tons.  It continued at roughly this level until the 2008 crisis.

Since then, on President Putin’s orders, Russia’s gold stockpile has been growing steadily at a rate of roughly 200 tons a year.

It now stands at 1,801 tons, accounting for 17% of the total gold stockpile held by the world’s central banks, giving Russia the sixth biggest gold reserves in the world after the US, Germany, Italy, France and China.

The Russian Central Bank’s gold purchases are a common topic of discussion on alternative media sites, with speculation sometimes voiced that they are intended to lead to a gold backed rouble as an alternative to the US dollar.

A little known fact is that in the 1950s the Soviet leader Joseph Stalin was actually committed to creating precisely that.

By the time of the German attack on the USSR in 1941 Stalin had amassed a gold reserve in the Soviet Central Bank of 2,600 tons (still a record), and following the end of the war he brought the USSR’s gold reserve back up to 2,050 tons, where it stood at the time of his death.

Stalin’s plan was to launch a fully convertible gold backed Soviet rouble by 1957, principally to fund trade with the USSR’s socialist allies including China.

Though the plan was dropped following Stalin’s death, the USSR continued to maintain a substantial gold reserve, which as of the time of Gorbachev’s election to the post of CPSU General Secretary in 1985 stood at 2,500 tons, only just short of the peak level to which Stalin had brought it.

Thereafter the Soviet gold reserve collapsed as the Soviet authorities frantically sold gold to buy desperately needed imports to stem the economic chaos caused by the late Soviet political crisis and Gorbachev’s unsuccessful economic policies.  As a result by June 1991 the USSR’s gold reserve had fallen to just 374 tons.

Today the rouble is freely convertible and the days when currencies were tied to gold – as they still were in the 1950s – have gone.

With Russia benefiting from the rouble’s flexible exchange rate there is no need for Russia today to link its currency to gold, as Stalin planned to do in the 1950s, and it would in fact be a massively regressive and counter-productive step for it to try to do so.

So why is the Russian Central Bank buying gold in such quantity?

Russia is today the world’s third biggest gold producer after China and Australia, producing around 250 tons of gold a year.  Of this around four-fifths (ie. 200 tons) is bought each year by the Central Bank.

This is a cheap and cost effective way to build up the Russian Central Bank’s gold and foreign currency reserves, which have grown from $360 billion in 2015 – the worst year of the recession – to $430 billion now (they were just $4.5 billion in December 1992).

Buying gold means that the Central Bank can increase the value of its gold and foreign currency reserves without spending roubles to buy foreign currency, a practice which is inflationary because it increases the amount of roubles in circulation and because it weakens the rouble against the value of the foreign currencies that the Central Bank is buying.

Whilst buying gold does increase the amount of roubles in circulation, the effect is less, whilst the value of the rouble against foreign currencies is broadly speaking unaffected.

This is not to deny that there is also a political aspect to the gold purchases.  Sergey Shvestov, the First Deputy Chairman of the Central Bank, recently put it this way

Under the instruction by President Putin, the Bank of Russia has been implementing the program of increasing the absolute share of gold in the gold and currency reserves of Russia for many years.I will not dwell on the geopolitical situation. Every smart person understands the value of gold in ensuring financial and economic security of the country.

This mirrors what Stalin is reputed to have told Chinese Premier Zhou Enlai in 1950 at a time when he was already planning his gold backed rouble

If a socialist country ties its currency to the capitalist currencies, then it may as well forget any idea of creating an independent self-sustaining socialist financial and economic system

Having said this, this argument can be overdone.  In reality it seems that much of Russia’s gold bullion is not held physically in Russia but rather in gold depositories in London and Switzerland, with the greater part in London, which is the undisputed world centre of the international gold trade.

If Western governments ever decided to seize Russia’s foreign currency reserves which are physically present on their territories – an action which Russian Finance Minister Siluanov has recently said Russia would treat as an act of economic war – then there is no obvious reason why they should not seize Russia’s stock of gold bullion held on deposit in London and Switzerland as well.

Recently Shvestov has suggested that the BRICS states – China, Russia, Brazil, India and South Africa – should set up their own gold trading centre on their own territory independently of London

The traditional (trade) system based in London and partially in Swiss cities is becoming less relevant as new trade hubs are emerging, first of all in India, China, and South Africa.  We are discussing the possibility of establishing a single (system of) gold trade both within BRICS and at the level of bilateral contacts.We assume that trade and clearing links should be established. The point is that gold buyers should decide on the place of purchase

However we are still some way from that, even if the Chinese and Russian Central Banks did take the first step in that direction last year when they announced plans to create a platform that would unite gold trading by the world’s two biggest gold buying countries: China and Russia.

In the meantime, even without such an alternative gold trading centre, it makes sense for the Russian Central Bank to continue its gold purchases.

In fact given steady Russian gold production of 250 tons a year there is no logical reason why it should stop doing so.

If the Russian Central Bank’s gold buying continues at current levels then in four to five years Russia’s gold stock should roughly equal its peak 1941 Soviet level of 2,600 tons, at which point – with Western Central Banks no longer buying gold to any significant degree, and assuming no great intervening crisis that might cause Russia to sell its gold – Russia should have the third biggest gold reserves in the world after the US and Germany.

In the meantime the Russian Central Bank is now expected to resume foreign currency purchases in February 2018.

Assuming that happens then the total value of Russia’s gold and foreign currency reserves should very rapidly reach the level of $500 billion it had reached just before the oil price fall and the rouble crash of the summer of 2014, which would bring the value of Russia’s gold and foreign currency reserves to the fourth largest in the world after China, Japan and Switzerland.