In a revealing short analysis, the European Central Bank (ECB) has turned its attention to the gold market (the article can be found here). It states that the euro area currently has an “exposure”—that is, claims and liabilities—related to gold of around €1 trillion (that would amount to roughly 6 per cent of the euro area’s GDP or 2.5 per cent of the total balance sheet of all euro area banks), an increase of 58 per cent compared to November 2024—mainly, of course, due to the fulminant rise in the price of gold.
The ECB analysts expertly address the recent surge in gold prices; they link the rising cost of gold to the high levels of uncertainty perceived by investors; they also analyze the distribution of gold demand across derivatives, spot instruments, and, more recently, a marked increase in COMEX futures (which, in turn, is presumably a reaction to U.S. import tariffs); and they emphasize gold’s role as a “safe haven” asset.
However, the ECB analysts express concern that in times of crisis, the gold market could become a source of danger: “Should extreme events materialise, there could be adverse effects on financial stability arising from gold markets.”
They see "vulnerabilities" in the financial system due to developments in the gold market. The ECB analysts write: “Such vulnerabilities have arisen because commodity markets tend to be concentrated among a few large firms, often involve leverage and have a high degree of opacity deriving from the use of OTC derivatives. Margin calls and the unwinding of leveraged positions could lead to liquidity stress among market participants, potentially propagating the shock through the wider financial system. Additionally, disruptions in the physical gold market could increase the risk of a squeeze. In this case, market participants could be subject to significant margin calls and/or have trouble sourcing and transporting appropriate physical gold for delivery in derivatives contracts, leaving themselves exposed to potentially large losses.”
It’s understandable from the ECB’s perspective to view the gold market as a risk: After all, the ECB and its employees are proponents—and part—of the fiat money system, a system in which money is created out of thin air through bank credit expansion; and in which commercial banks operate on a fractional reserve basis, meaning they have more liabilities due on any given day than actual cash on hand.
Such a fiat money system is indeed vulnerable to a so-called “loss of confidence”—that is, a bank run (when customers show up at the teller demanding their cash and banks turn out to be insolvent). Euro area banks have daily payable liabilities of €9.1 trillion, but only €2.8 trillion in central bank reserves. Their actual cash holdings (coins and banknotes) are unknown, but are likely only a small fraction of their daily liabilities.
But using the term "loss of confidence" in this context is actually inappropriate. What the ECB analysts are really afraid of is a mass awakening by market participants: that people realize what kind of fraud is truly happening in the fiat money system—and that gold market turmoil could expose this.
The global gold market doesn’t just involve the trade of physical gold (bars and coins), but is also largely conducted via paper instruments, hence the term “paper gold market.” Trading instruments include derivatives (gold options, gold forwards, gold futures) as well as gold swaps, exchange-traded funds (ETFs), exchange-traded products (ETPs) and certificates. The total trading volume in the gold market (physical plus paper gold) is enormous, currently around $233 billion per day. That’s slightly more than half the market value of gold produced annually.
Should the scenario feared by ECB analysts ever come to pass—namely, that market participants begin converting their paper gold into real, physical gold on a large scale—there could indeed be massive market disruptions, which would eventually spill over into the fiat money system. Consider the losses banks might suffer on open derivative positions; or delivery requests on futures exchanges and from ETFs where the necessary physical gold is not available in the right quality and at the right time. Massive liquidity shortages could follow, affecting interest rate, equity, and commodity markets.
But the problem isn’t the gold market—it’s the fiat money system. If the monetary system were sound, if banks had 100 per cent backing for their liabilities, there would be no such thing as the threat of systemic payment defaults in the banking sector—regardless of any disruptions in credit or commodity markets.
Moreover, developments in the gold market are not independent of the fiat money system and the behaviors it encourages among banks and financial institutions. The latter enjoy privileged access to central bank money, and they know that in a crisis they can rely on central bank support. And they convince their clients that paper gold products are just as good—if not better—than physical gold, because, say, ETFs and certificates are easy and cheap to trade and supposedly safe.
The deception of the fiat money system has not left the gold market untouched. That’s why it’s not out of the question that one day, gold investors might pull the emergency brake and demand to convert their paper gold into physical metal. And when issuers of financial products that have promised gold redemption can no longer deliver, it will become clear that the emperor has no clothes.
This may be labeled as a “vulnerability” of the financial system to gold market events. But it’s a bit like the thief shouting “stop, thief!” Or the shoplifter complaining that the store detective, who had always been asleep until now, suddenly woke up and became a threat to him.
And with that, I conclude my brief commentary and emphasize: There are very good reasons to hold gold in your portfolio if you’re a long-term investor—preferably in physical form. Physical gold is mankind’s base money—it cannot be devalued by central bank policies. Properly stored, it carries no counterparty and/or default risks. That ECB analysts now see potential financial instability arising from gold market developments inadvertently reveals nothing less than the overstretched, unreliable, and fraudulent nature of the fiat money system.
