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You may have heard the phrase “gold reserve” mentioned in the news. A gold reserve represents a store of gold—either as coins or bullion—held by a bank or a government, not by a private individual.
Now that you have a basic understanding of the definition of a gold reserve, we can ask: what is the purpose of a gold reserve? Gold reserves often play an essential role in a given country’s economy, but this level of importance varies by nation.
You can learn more about how gold reserves work and their purpose with our team at the Oxford Gold Group. Get answers to all your questions about gold and other precious metals by contacting us at 833-600-GOLD.
A Brief History on Gold Reserves Around the World
Governments and banks worldwide have held gold reserves for hundreds of years. Traditionally, governments held the gold reserves for a country. Private citizens and governments used gold and other precious metals to make purchases.
The First Usage of Paper Money
Countries in Europe only began using paper money in the 16th century. During this time, many people still avoided utilizing this form of currency. As a result, we only saw increased usage of paper money in the 18th century.
In many cases, banks and governments blended the use of gold, paper money, and other payment methods. Around the start of the 19th century, banks stepped in and essentially took over the role of storing and handling gold.
Setting Up the Gold Standard
During this time, banks in countries, including the United States, held a reserve of gold to pay back any paper money issued to people who used the bank. The population expected that if they took their paper money back to the bank, they would receive the same amount of gold in repayment.
Note that many governments did not use a pure gold standard. For example, the United States used a bimetallic standard utilizing both silver and gold at one point.
However, over time the value of silver dropped. This drop in value caused gold to slip out of circulation for some time. Eventually, England became the first country to adopt a pure gold standard for monetary issues.
The Growth of Central Banks
Over time, many countries formed central banks. These banks gathered the gold stored in smaller commercial banks. The central banks then provided notes (or paper money) for use by commercial banks.
As these banks grew more prominent and the economic climate changed, many countries faced increasingly tricky financial situations. For example, the stock market crashed in 1929, when banks overextended their funds, and prices for commodities collapsed.
The gold standard made it hard for countries to adapt to these changing conditions. Some countries responded by revaluing gold or setting up plans to work with other nations. However, the situation continued to worsen until the U.S. broke the gold standard.
Significant Changes to the Use of Gold Reserves in the U.S.
Currently, most banks in the U.S. do not have a large gold reserve. This change began in the 1930s, after the stock market crash, when the government required everyone (including private citizens) to turn over their gold and silver. This requirement covered items like:
- Gold coins
- Gold bullion
- Gold certifications
The U.S. government took this step to try to control issues with inflation and the value of the dollar. However, the situation continued to pose a challenge over the next four decades.
Eventually, the country broke the gold standard. Before this time, the dollar’s value correlated directly to the value of gold. Since the 1970s, the U.S. has not used a gold standard, though the country does allow private citizens to purchase and keep precious metals once more.
Note that not all countries worldwide treat gold in the same way as the U.S. This factor makes it more challenging to answer the question: what is the purpose of a gold reserve?
Ways Countries Could Use Their Gold Reserves
The purpose of a gold reserve varies based on the unique needs of each country. It’s essential to recognize that just because one country uses gold in a specific way, it does not mean that others follow the same habits.
Keeping this factor in mind, we can review some of the most common ways countries use their gold reserves aside from the U.S.
As a Way to Handle Inflation
Inflation occurs in a country when prices increase while the purchasing power of money decreases. During periods of high inflation, many countries purchase gold because this metal retains its value better than many alternative currencies such as silver, rare earth elements, and property.
Investors also purchase gold during periods of high inflation as a way to protect their finances in the future.
In Connection with Importing and Exporting
The value of a country’s currency depends partially on the balance between imports and exports. Countries that import more than they export often see a decline in currency value. However, currencies grow more valuable if you export more than you import.
Countries may attempt to increase the value of their currency by exporting gold from a gold reserve. Countries that produce gold may also sell this precious metal to other governments worldwide as a way to increase their country’s currency value.
As a Way to Value Currency
Many countries no longer use a gold standard. However, historically there has been a direct relationship between currencies and the value of gold. Therefore, any country that decides to use the gold standard would require a gold reserve when handling all fiscal matters.
Buying Gold Impacts the Value of Other Currencies
As you can see, a gold reserve may play an essential role in the function of governments around the world. However, governments often do not simply go out and purchase as much gold as possible.
Many countries have to balance the benefits of gold against the repercussions of purchasing this precious metal. Governments may print more money to buy gold, which can reduce the value of the local currency. Governments consider these factors when growing their gold reserve.
Gold Reserves and Fiat Money
Gold reserves used to play a significantly more important role in financial systems globally. However, countries around the world no longer hold to the gold standard. In fact, the U.S. severed the connection between money and gold in 1971.
Since the 1970s, countries worldwide have used a fiat system for monetary matters. Fiat money does not have a value based on a physical commodity, like gold or silver. Instead, its value changes based on its relationship to other currencies.
Generally, changes in different foreign-exchange markets determine the value of fiat currency. These factors mean that the value of currencies can change quickly and often without warning, leading to a degree of instability in financial systems worldwide.
The Value and Usage of Gold in Today’s World
What is the purpose of a gold reserve? Today, many governments strive to limit their reliance on gold and other precious metals. However, gold still serves as a reliable way for individuals and governments to invest.
Gold tends to hold value over long periods, often increasing in value during periods of economic instability or when fiat currencies begin to lose value. Therefore, many people and governments choose to purchase gold as an investment.
Some people suggest returning to a gold standard. Such a system would help stop inflation and prevent banks from overissuing money. These factors would result in more stable prices. However, a gold standard often proves very inflexible, making it harder for countries to operate in a rapidly changing world.
Consider Building a Gold Reserve of Your Own
The professionals usually use the term “gold reserve” when discussing precious metals held by governments and banks. However, you can invest in this precious metal as a way to store your wealth.
Investing in gold comes with many benefits. This precious metal retains its value and often appeals to collectors if you want to resell the coins, bullion, or bars you have collected. While other currencies fluctuate, gold tends to increase in value steadily.
Many individuals also enjoy collecting specialized gold coins produced and released by central banks around the world. You may also decide to invest in silver, which generally costs less than gold but is still considered a reliable investment.
We recommend that you determine how you’ll store gold before making your purchase. You may also consider engaging in the gold commodity market if you do not want to purchase physical bullion or coins. You can learn more by reaching out to our team.
Review the Purpose of a Gold Reserve Today
What is the purpose of a gold reserve? The purpose of a gold reserve often varies based on the needs of a country or bank. At one point, countries tied their currency directly to gold, resulting in a gold standard, but that ended in the 1970s.