How Central Banks Are Debasing the Currency: Is This the Year for Gold?
Right now, the US Federal Reserve is treading on a thin line.
On one hand, they are flooding the system with liquidity to try and avoid a recession due to the devastating effects the COVID-19 lockdowns are having on the economy. To that end, they have lowered interest rates to record lows and restarted unconventional policies like quantitative easing.
On the other hand, they need to increase liquidity without eroding confidence and debasing the currency.
Quantitative easing is something they had already trialed in 2008, when the Fed bought treasuries and mortgage-backed securities to prop up the economy.
But today, the economy needs more help.
The Fed has restarted their quantitative program and expanded it to include corporate bonds.
Problem is, the virus didn’t hit at the best time. We are coming off a long bull market, with lots of debt, high asset prices and low growth. All these measures will aggravate that.
It’s amid this scenario that gold is gaining traction.
It’s something that had been brewing for a while…
In 2018, central banks bought 656 tonnes of gold, the most since 1967, when the US dollar was still convertible to gold. And then repeated in 2019 with another 650 tonnes. Much of this increase in demand came from central banks in emerging countries, like Russia and Turkey.
Gold has also been gaining ground because of low interest rates. You see, gold has no yield. In fact, that’s one of the main criticisms for it. Yet when real interest rates turn negative, gold becomes more attractive.
Gold usually takes centre stage when there is fear in the market because it’s seen as a safe haven.
The pandemic has rattled confidence, and increased the demand for gold. According to data from the World Gold Council, demand for gold-backed ETFs in the first quarter of this year saw huge inflows, which increased global holdings to a record-high 3,185 tonnes.
And hedge funds are also getting in on the back of central bank’s actions. As The Financial Times reported:
‘Some of the world’s largest hedge funds are raising their bets on gold, forecasting that central banks’ unprecedented responses to the coronavirus crisis will lead to devaluations of major currencies.
‘Paul Singer’s Elliott Management, Andrew Law’s Caxton Associates and Danny Yong’s Dymon Asia Capital are all bullish on the yellow metal, which has risen about 12 per cent this year. They are wagering that moves to loosen monetary policy and even directly finance government spending, intended to limit the economic damage from the virus, will debase fiat currencies and provide a further boost to gold.’
What could happen next?
So far, the price of gold for the year in US dollars has seen an over 11% return, and in Australian dollars, the gain is close to 22%.
It remains to be seen if central banks will manage to avoid a recession, but all these unconventional policies and artificially low interest rates could be good for gold.