New Golden Age - Increasing Gold Reserves

Foreign exchange reserve management considerations

Gold is a traditional reserve asset that fits well into the conservative reserve management framework of central banks. The primary purpose of holding foreign exchange reserves is to ensure monetary policy and financial stability, so when a central bank is faced with a choice between safety, liquidity and yield, it typically chooses safety and liquidity over yield.

In terms of the requirement for safety, one of the most important characteristics of gold is that there is no risk of bankruptcy. Central banks' foreign exchange reserves are predominantly made up of fixed-rate assets, mainly highly rated short-term government bonds, supranational and agency bonds. These are the assets that offer the lowest possible credit risk for the investor in the investment portfolio. At the same time, they also represent the debt of the respective issuers, whose solvency or willingness to pay may be in doubt in extreme circumstances. This is not the case with gold: gold does not represent anyone's liabilities and can therefore be considered a financial instrument that is truly free from the risk of default.

Gold is also a highly liquid asset. The gold market is comparable to other major market segments in terms of market size, transaction costs and daily turnover. The daily turnover of the gold market is estimated at around USD 250 billion. During the market turbulence in March 2020, gold experienced significant position liquidation and consequent price falls, similar to other asset classes. However, analysis has shown that during the turbulence, gold was used as a source of liquidity, i.e. investors obtained the funds they needed to meet their deposit liabilities related to other asset classes by selling gold. In addition to its liquid market, gold has a low correlation with price movements in other asset classes and therefore has favourable diversification characteristics in traditional reserve portfolios.

Strengthening trust

"In extreme cases, no one will accept paper money. Gold will always be accepted," said Alan Greenspan, Chairman of the Federal Reserve, the US Federal Reserve, in 1999 at a hearing of the House Banking Committee, the US House of Representatives. Gold boosts confidence and enhances economic stability. This is true under normal circumstances, but it is particularly true in extreme market conditions, in times of crisis or major geopolitical uncertainty, when economic strategy considerations and the role of gold as a safe haven are heightened.

Gold, especially when held in physical form, is an asset that can strengthen trust in a country both within and outside its borders. One of the most important changes in central bank behaviour after the global financial crisis was the need to store gold domestically rather than in remote financial centres. Central banks announced one repatriation programme after another. In addition to extreme market conditions, global geopolitical uncertainties also make the availability of gold and the advantages of domestic storage over foreign placement an important consideration. The huge difference between the two is obvious.

Historical links

Hungarian history shows that the country has always had a special relationship with gold. The Carpathian Basin has been rich in gold deposits since ancient times. Archaeological finds show that gold mining was already practised in the area in the early Bronze Age, and the rich gold mines encouraged the Roman Empire to conquer and conquer the area.

In the Middle Ages, between the 13th and 15th centuries, for about 300 years, Hungary was the country in Europe where most gold was mined. At that time, Hungary accounted for 25 percent of the world's gold production and 20 percent of its silver production. In European terms, the figures are even more significant: at its peak, the Kingdom of Hungary accounted for around 80% of the continent's total gold production, with an annual output of 2,500 kg. In addition to Hungary, the Czech Republic was another major producer, followed by the German-Roman Empire with its gold deposits in the Rhine valley. Hungary retained its leading position in the extraction of precious metals until the discovery of the Americas and the Turkish occupation of the country.

There were several types of gold coins in circulation in Europe at the time, the most famous of which was the Venetian gold ducat. However, other progressive regions produced their own coins, including King Charles Robert of Hungary in 1325. These coins, of a similar weight and purity to the Venetian ducat, were also widely accepted as currency throughout Europe. Hungary minted ducats until 1915.

Gold in danger

The MNB has held gold reserves since its foundation in 1924. During the period of stabilisation following the First World War (1924-29), the stock grew rapidly and the value of the new currency, the penguin, was pegged to gold in 1927. The largest reserve stock, of some 53 tonnes, was established before the Great Depression and remained stable until the Second World War.

The domestic gold reserve was personally protected by the Hungarian central bankers. The most tense period of the Hungarian central bankers' lives probably came in the last months of the war, when some 400 volunteers from the central bank staff managed to save the Hungarian national treasures from the occupying forces. These volunteers accompanied the so-called gold train carrying 30 tonnes of gold melted into 25 kg blocks and the entire supply of banknotes in pengo. The estimated value of the shipment at the time was around $1 billion. The train left the capital in November 1944 and arrived in the Austrian town of Spital am Pyhrn in January 1945, where it was protected by the staff of the Central Bank until the arrival of American troops under General George Patton in May 1945.

After the war, in August 1946, the shipment - including 30 tonnes of gold reserves - was returned to Hungary with no shortage. This was a rare occurrence at the time. This 30 tonnes of gold was one of the main pillars of the post-war economic and financial consolidation and was used to introduce the new currency, the forint.

Saving the gold reserve - the story of the MNB gold train

The distinguished officers of the National Bank of Hungary showed extraordinary courage in difficult circumstances to save the country's gold reserves from the ravages of war, and have deservedly earned the respect of posterity.

Years of active treatment

Like all other elements of the foreign exchange reserve, the gold reserve was actively managed. This was also the case in the 1970s and 1980s, when the MNB resumed the publication of reserve data after some two decades of complete silence. Unfortunately, very little information is available for the period before the change of regime. The data that do exist show that gold stocks peaked at around 70-80 tonnes and that sales and purchases were mainly driven by price developments and exchange rate expectations.

Subsequently, the active management of gold stocks has been based on considerations of returns. Until 2018, the MNB held gold in unallocated form in London with international custodians and used all the tools at its disposal to increase the available yield. Depending on market conditions, the central bank has either not invested gold, has outsourced gold to counterparties on a short-term basis, or has taken advantage of occasional arbitrage opportunities to convert gold into other currencies and invest the proceeds in money market instruments. Overall, these investments generated returns in excess of the storage costs.

The return of national treasures

The most important relics of Hungarian history returned to Hungary in the 20th century (as described in detail in the last chapter of the Golden Book published by the National Bank of Hungary in 2018), the first of which was the Holy Crown, the symbol of Hungarian sovereignty, which was used to crown kings throughout most of the Kingdom of Hungary's existence. Its history is even more adventurous than that of the Hungarian gold set. It was smuggled out of the country shortly after the gold train crossed the border and was only repatriated in 1978.

The second most notable success was the reacquisition of the Seuso treasure, a late Roman Empire silver treasure from the Roman province of Pannonia, found in Hungary in the 1970s. The most significant such find of its kind in the world consisted of 14 large decorated silver vessels and the copper silver used to store them. The total weight of the known pieces is about 70 kg, made of silver of exceptional purity.

The repatriation of the gold reserve is part of this. When the news was made public, public opinion was clearly positive, which is direct proof that gold builds and strengthens confidence.

The Golden Book

The Gold Book of the National Bank of Hungary summarizes the relationship between Hungary, the Hungarians and gold and collects them in a single book.

Operating result

The Monetary Council of the MNB continuously monitors developments in the gold market and decides on all possible aspects of the management of the gold reserve accordingly. Following the repatriation and revaluation of gold reserves, the Council decided to realise the profit available on the position at the end of 2019, in line with international trends. Following the outbreak of the Covid-19 epidemic, it subsequently decided to pay a substantial dividend to the State budget as a contribution to the central costs of the fight against the epidemic. The gold reserve for national strategic objectives was not sold, but increased to 95.4 tonnes in 2021 and is physically stored in a domestic repository.