How Gold Affects Currencies
As previously mentioned, gold is used to hedge against inflation. When a country is experiencing high levels of inflation, investors will buy large quantities of gold. During inflationary times, the demand for this commodity will increase as a result of its limited supply and inherent value. Unlike other currencies, gold cannot be diluted and therefore can retain its value to a better degree. The value of a countries currency is linked to its exports and imports. When a countries imports exceeds its exports, there will be a current account deficit in the balance of payments and a decline in their currency. However when a countries exports exceeds its imports, this will result in a current account surplus and hence the currency will increase. It therefore goes, that when a country exports gold, their currency will increase when the price of gold increases, as this increases the value of the total exports of the country. This can have the effect of creating a trade surplus or to offset a trade deficit.
When gold is purchased by the central bank, it will affect the demand and supply of the currency and may cause inflation. This is because banks rely on printing money to buy gold, and thereby creates an excess supply of currency.