US Treasuries remain the world’s dominant reserve asset, but geopolitical risks can change how central banks assess the trade-off between liquidity and protection from foreign jurisdictions. This column argues that geopolitical risk can increase the demand for gold relative to sanctionable sovereign assets, putting upward pressure on the gold price and sovereign bond yields. It finds evidence of active portfolio adjustment consistent with this mechanism and shows that the adjustment is stronger in countries less aligned with the US. The results suggest that geopolitical considerations are becoming increasingly relevant alongside the traditional financial determinants of reserve allocation.
According to the European Central Bank’s latest report on the international role of the euro (ECB 2026), the gold share in global official reserves rose to 27% at the end of 2025, exceeding central banks’ holdings of US Treasuries. Part of this increase reflects the exceptional rise in the gold price. But valuation effects are not the whole story: central banks have also continued to accumulate gold. Official purchases remained unusually high in 2025 despite record valuations, extending a broader shift towards gold documented by Arslanalp et al. (2023).
The ECB report also highlighted that geopolitical risks have become an increasingly important concern for central banks and that some of the largest gold buyers face greater external geopolitical risk. Why, then, would reserve managers acquire more of an asset that pays no interest, is costly to store, and is considerably less liquid than government bonds?
In a recent paper (Arvai et al. 2026), we argue that geopolitics changes the way reserve managers evaluate these characteristics. US Treasury securities remain exceptionally liquid, carry little credit risk, and are, in this financial sense, quintessential safe assets. But they are also liabilities issued under US jurisdiction. The freezing of Russia’s foreign reserves in 2022 made this distinction particularly visible: safe assets are not necessarily the safest option for countries involved in geopolitical tensions.
Figure 1 Cross-country heterogeneity in gold reserve accumulation
(a) Alignment with the US
(b) Gold share in total reserves
Note: Panel (a): UN voting alignment with the US (1= full alignment). Panel (b): gold share of reserves, indexed to 100 in January 2013. Sources: Voeten (2009), Bailey et al. (2017), IMF.
On the other hand, gold is not the liability of another government and, when stored outside the reach of a potentially sanctioning jurisdiction, is less exposed to this particular form of geopolitical risk. However, it is less liquid than government bonds, pays no interest, and entails storage costs. Our framework therefore treats gold not as a substitute for liquid safe assets, but as an asset with a different mix of financial and geopolitical characteristics. Rising geopolitical risk can therefore alter this trade-off without making gold a full substitute for liquid sovereign assets.
A trade-off between liquidity and political safety
We formalise this intuition in an endogenous portfolio model in which financial sanctions are modelled as a form of default. A dominant sovereign issues liquid bonds to domestic and foreign investors. Investors can also hold gold, which is in fixed supply and provides weaker liquidity services. The key asymmetry is that the sovereign can impose selective sanctions on the foreign investor’s bond holdings, whereas gold in the model is insulated from those sanctions.
In tranquil states, the liquidity advantage of sovereign bonds dominates, and the foreign investor willingly holds them. In a turbulent geopolitical state, expected sanctions risk rises. The effective attractiveness of bonds to the foreign investor falls, even before sanctions are imposed, inducing a reallocation towards gold. This substitution also affects equilibrium liquidity services and convenience yields.
The model delivers two implications that we take to the data. First, higher geopolitical risk increases demand for gold relative to sanctionable sovereign bonds, putting upward pressure on the gold price and sovereign bond yields. Second, foreign investors adjust their portfolios towards gold and away from sovereign bonds. Importantly, the second prediction concerns quantities as well as valuations: a rise in the price of an unchanged stock of gold is not sufficient to account for the mechanism.
What do the data say?
We test the model’s central prediction using a quarterly panel of 37 reserve managers from 1985 to 2024. Geopolitical risk is measured using country-specific versions of the index developed by Caldara and Iacoviello (2022), while geopolitical alignment with the US is inferred from United Nations General Assembly voting. Local projections trace the response of asset prices and reserve portfolios after a geopolitical-risk shock.
At daily frequency, geopolitical shocks raise gold prices and US Treasury yields, a pattern consistent with the relative repricing predicted by the model. Yet the evidence is not purely a valuation story. In the quarterly data, gold holdings also increase after geopolitical shocks when we control for valuation effects, while foreign-exchange exposure moves in the opposite direction. The results therefore point to active portfolio adjustment in addition to changes in relative asset prices.
Figure 2 condenses the main reserve-composition result into the same outcome in both panels. The left panel shows the average response of the gold share following a geopolitical shock comparable in size to the Russian invasion of Ukraine. The right panel shows the additional response among countries with below-median alignment with the US. Their reallocation is markedly stronger, in line with the model’s prediction that concerns about jurisdictional exposure should matter more for countries that are geopolitically distant from the US.
Figure 2 Gold shares rise more in less US-aligned countries after geopolitical shocks
Note: Quarterly local projections after a 2.5-standard-deviation geopolitical-risk shock. (a) Average response; (b) additional response below median US alignment. Bands: 68% and 90%.
These results should nevertheless be interpreted carefully. They show that geopolitical risk can induce reserve managers to shift portfolios towards gold and away from foreign-exchange reserves. They do not, by themselves, imply that gold is replacing the dollar as the dominant reserve asset, nor that every increase in gold’s reserve share reflects active purchases rather than valuation changes.
What this means for the international monetary system
The dollar’s dominant position rests on advantages that are difficult to replicate: deep and liquid financial markets, a large supply of safe assets, and a central role in international finance, as discussed by Arvai and Coimbra (2023). Nothing in our results suggests that gold can reproduce these advantages. In particular, its limited liquidity makes it an imperfect substitute for US Treasuries.
What our findings suggest instead is that geopolitical fragmentation adds another dimension to reserve management. Assets under foreign jurisdiction may combine very high financial safety with some degree of geopolitical exposure. Gold, provided that it is held outside the relevant foreign jurisdiction, offers a way to reduce that exposure — but at a significant liquidity cost.
The current increase in gold holdings may therefore represent a portfolio adjustment at the margin rather than a wholesale move away from the dollar. It may also prove partly transitional. If another asset were eventually able to combine the liquidity and safety of US Treasuries with greater insulation from geopolitical risk, reserve managers could have less reason to rely on gold for that purpose.
For now, our evidence establishes a more limited result: geopolitical risk makes gold relatively more attractive, and the effect is strongest among countries less closely aligned with the US. Whether the cumulative effect of such portfolio choices ultimately produces a lasting erosion of dollar dominance is a broader question. But the renewed role of gold suggests that geopolitical considerations are becoming increasingly relevant alongside the traditional financial determinants of reserve allocation.
Source : VOXeu
