Bank of Tanzania’s Move to Purchase Gold: Is it an Effective Hedge Against Inflation?

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The Bank of Tanzania’s move to start gold purchases to bolster its foreign investment is judicious, yet doubtful of its effectiveness. Gold prices tend to skyrocket when there is global uncertainty or inflationary pressures, both of which currently are true. The Ukraine-Russia ongoing war has certainly created tepid market conditions in commodities and spiked prices, resulting in imported inflation in many local markets globally.

To curb the risk of inflation, which has adverse effects on long-term growth and tends to hurt low and fixed-income earners more, central banks around the world have increased rates to curtail the effect.

The US Federal Reserve’s raising interest rates mops the excess dollars in negative earnings assets towards high returns, resulting from high rate hikes. Also, with rates increasing, the number of dollars in circulation will decrease, creating scarcity-dollar appreciation- other currencies depreciate (TZS).

To counter the depreciation, central banks will need an asset consistent with the US money supply to purchase the dollar at a non-punitive exchange and, at the same time, maintain their anchor of price target. Hence, the move to build gold reserves. Nevertheless, how exactly is gold better than other precious metals in times of uncertainty?

Read related: Tanzania’s Gold Reserve: What A Strategic Asset! A Path to Resilience.

First, it is worth remembering that BoT’s mandate is to maintain price stability, regulate the financial markets, and formulate policies that foster economic growth. To that end, its business is to create stability and resilience in the economy in the short and long run. To provide resilience in the long term, it will need to seek to eliminate anything that promotes economic fragility. With that objective in mind, it will need to hold some assets with a moat in part of its incumbency and part of its price.

Thus, it will require constantly looking for ways to eliminate errors- in all categories of finance of the economy, their monetary policy meeting regularly and the repetitive reports. In BoT, buying and owning gold is somewhat paradoxical because people will ask why you own this useless lump of metal? The paradox of Gold is in its utility and its uselessness- if you were to look at a periodic table, it would be the equivalent of the best block of land because it has this unique combination of inertness and density on the periodic table.

In addition, the inertness, which makes it useless in some ways, makes it a natural perpetuity gold that does not react chemically. It gives it permanence and its low beta characteristics; it is not primarily used in the industrial cycle, like copper or oil or iron ore. Moreover, it has a low correlation to the business cycle and long duration. In addition, that is what made it nature’s hedge asset. This could explain Mr Tutuba’s rationale for gold shopping for the bank.

In addition, even though gold has no yield, it is scarce. There is less than one ounce per capita in the world, as the supply of money has increased over the last 50 years after the breakdown of the Bretton Woods agreement. Gold has not offered a yield but has accreted in line with the world money supply. Therefore, it has offered a return and has not suffered from beta risk, management dilution, or entropy.

Also, read Bank of Tanzania’s Game-Changing Policy Shift: A New Dawn for Economic Stability.

It is still in the periodic table and occupies its position of incumbency. One must consider how other businesses have stacked up relative to a lump of gold. Many businesses have faded risk. They have a generational half-life. Secondly, most businesses have beta risk. The late coming to the show of BoT is merely a common tendency of government laxity.

It is worth remembering that gold cannot and will not replace money as money lacks intrinsic value, as gold or other precious metals, therefore, need not back value. BoT exercise is merely the famous problem of “The dollar is our currency, but it is your problem”. If most exports globally are denominated in dollars, no sufficient gold bullion will be enough to affect the exchange. However, having gold receives in an inflationary world, can help, as people flock to gold during war and period of uncertainty, one can exchange for a scarce dollar.

“When a measure becomes a target, it ceases to be a good measure”- Goodhart’s law.

Edward Chancellor’s book ‘ The Price of Time ‘ is a fantastic read about the history of interest rates and gold. I recommend you read it.

Ezekiel Lengaram is a Researcher in Economics at Wits University. My teaching and research focus are on the theory of Macroeconomics, Computational Economics and Applied Computational Mathematics

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