For decades, the global financial system has relied on United States Treasury securities as the ultimate reserve asset. These bonds offer deep markets, high liquidity, and a stable institutional backing. However, recent geopolitical events have highlighted a specific vulnerability within this system.
When the US and its allies froze Russia’s foreign reserves in 2022, it became clear that financial safety is not the same as political control. A government bond might be safe from financial default, but it remains vulnerable to the legal and political authority of the country that issues it.
A recent study outlines how this dynamic is shifting global demand for safe assets. In an NBER working paper, economists Kai Arvai, Nuno Coimbra, and Marco Pinchetti investigate how the threat of international sanctions alters the portfolio choices of central banks. Their research focuses on the trade-off between the high liquidity of sovereign bonds and the political neutrality of physical gold.
The Trade-Off Between Liquidity and Sovereignty
The researchers begin by identifying a fundamental tension in reserve management. Sovereign bonds issued by a dominant power like the US provide unmatched transactional convenience during normal times. These assets are easy to buy, sell, and use in global financial operations.
However, holding these bonds requires access to the legal and payment infrastructure controlled by the issuing country. If diplomatic relations break down, the issuing country can restrict access or freeze the assets entirely.
Gold offers a different set of characteristics. It is more expensive to store and less convenient for daily international transactions. Yet, if held domestically or in a neutral jurisdiction, physical gold retains its value outside the reach of foreign legal systems. The authors argue that as geopolitical tensions rise, reserve managers are forced to weigh the convenience of bonds against the custodial sovereignty offered by gold.
Modeling the Shift to Gold
To understand how these variables interact, the research team developed a mathematical model of international asset choice. The model features a dominant sovereign borrower, a domestic investor, and a foreign investor. It simulates how asset prices and portfolio allocations change when the political environment shifts from tranquil to turbulent.
In the model, tranquil periods lead foreign investors to favor sovereign bonds because of their high liquidity. When the environment becomes turbulent, the probability of sanctions increases. This prompts foreign investors to adjust their portfolios to protect their wealth.
The model illustrates a specific chain of events. Fearing that their bonds might be frozen, foreign investors sell their sovereign debt. To replace the financial security those bonds provided, they purchase physical gold. This sudden shift in demand reduces the available pool of global liquidity, driving up the price of gold and pushing down the price of the sovereign bonds.
Testing the Theory with Data
The researchers then tested the predictions of their model using two sets of real-world data. First, they looked at high-frequency daily financial data from 1990 to 2025. They analyzed how gold prices and 10-year US Treasury yields responded to sudden spikes in a widely used geopolitical risk index.
The daily data aligned with the model’s predictions. Following a sudden geopolitical shock, gold prices persistently rose. At the same time, the yields on 10-year US Treasuries increased, indicating that investors were demanding a higher premium to hold the debt.
Next, the researchers examined a quarterly dataset of official reserve portfolios from 37 countries spanning 1985 to 2024. They wanted to see if the asset repricing observed in daily markets translated into deliberate policy shifts by central banks. They tracked the share of gold within total reserves, as well as the absolute quantity of gold held by each country.
The analysis revealed that periods of elevated geopolitical risk are linked to systematic adjustments in central bank reserves. Following geopolitical shocks, countries gradually and persistently increased both the share of gold in their portfolios and their total gold holdings in absolute terms. Simultaneously, they reduced their exposure to foreign exchange reserves.
The Role of Geopolitical Alignment
The researchers also investigated whether a country’s diplomatic relationship with the US influenced its reserve management decisions. To measure this, they used a standardized metric based on United Nations General Assembly voting records. Countries that frequently voted in tandem with the US were considered highly aligned, while those that voted differently were considered less aligned.
The data showed a stark divergence based on this alignment metric. Close US allies maintained relatively stable gold shares in their reserve portfolios, even during periods of global tension. The shift toward gold was heavily concentrated among countries that were less aligned with the US.
The researchers interpret this as evidence that the reallocation is driven by specific concerns over sanctions and political access. Countries that perceive themselves as more vulnerable to US diplomatic pressure are the ones actively trading the liquidity of the dollar for the political safety of gold.
Broader Changes in the Reserve System
The shift in reserve management extends beyond the purchase of physical gold. The researchers also analyzed aggregate data on the currency composition of global foreign exchange reserves. They found that heightened geopolitical risk is associated with a diversification away from the US dollar.
Following a geopolitical shock, the aggregate share of US dollars in global reserves declined. This drop was matched by an increase in the share of other currencies, primarily the Euro. The authors note that while shifting to other fiat currencies reduces reliance on the US, it still exposes the reserve holder to foreign legal jurisdictions.
Finally, the study examined where central banks choose to store their physical wealth. Historically, many countries have kept their gold in major offshore financial hubs. The researchers analyzed data on gold held in custody at the Bank of England and the Federal Reserve Bank of New York.
They found that geopolitical risk shocks are linked to a subsequent decline in the amount of gold stored at these two major institutions. Within two years of a significant geopolitical shock, aggregate offshore gold holdings at these centers declined by up to 180 tonnes. This suggests that some reserve managers are reducing their exposure to the legal jurisdictions of traditional financial capitals.
