How Your Savings Are a Government’s Plaything

How Your Savings Are a Government’s Plaything

The gold price in US dollars is breaking out as I write this. After months stuck in a sideways range, is this the move upwards we’ve been waiting for, at last?

To answer that question, you’ve got to ask what makes the gold price itself move. And that’s not straightforward.

Some argue that high inflation is what makes the gold price rise. But that’s not the entire story, historically speaking. Not that I’ll bore you with the details of the counter examples.

Others claim that gold benefits from general monetary disorder — when there’s very high inflation, or deflation, but not when the porridge is just right.

This sounds good, but it doesn’t explain gold’s bull market from the year 2000.

During this period inflation was so low and stable that they called it the ‘Great Moderation’, and Federal Reserve Chair Alan Greenspan had done such a good job that Senator John McCain suggested he’d be reappointed even if he died: ‘Not only would I reappoint him, but if he died we’d prop him up and put sunglasses on him.’

If gold benefits from monetary disorder, why did it boom during a period of such apparent stability?

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The opt out for wealth

Simple supply and demand arguments are tough to square with gold’s price performance too. First, the price is set in the financial trading market, not in the physical gold market.

Secondly, gold is used as an opt out for wealth.

An opt out of the financial system. But this means that there’s a huge amount of gold sitting in vaults, ready to be sold should the price rise.

That’s not really true of other commodities, which are put to use and thereby not available for sale in the same way. We never really ‘use up’ our gold, we just store it away for safekeeping. That means it’s still available for sale, in a sense.

The supply can be put on the market at short notice.

Perhaps the best indicator for the gold price takes some explaining. But I think this indicator is about to become the most important one in your life. And for the rest of your life.

So, it’s worth taking the time to understand it.

The real interest rate is the interest rate minus inflation. The idea is that it’s what it actually costs you to borrow money, given the price of whatever you buy with that money will rise at around the pace of inflation.

If you borrow money at 5%, with inflation at 3%, then it’s really only costing you 2% to borrow the money, because the price of the thing you bought is rising in value at the pace of inflation.

That’s an abstract and generalised argument, but it sets the context for the point I’m about to make.

What if the real interest rate is negative? What if prices are rising faster than the cost of debt? What if inflation is higher than the interest rate?

Then borrowing money is, in a way, free.

Imagine borrowing money to buy a house when the house price is rising faster than the interest rate. It amounts to a no-brainer.

And so, during such times, there’s a buying and borrowing spree in the economy.

Or, perhaps more importantly, saving money is a bad idea in such an environment. Because consumer prices are rising faster than those savings earn interest to recover the losses from inflation.

In that environment, people turn to alternatives to savings at the bank. And alternatives to bonds, which are similar to savings at the bank in that they earn interest.

Which, in this scenario, is a rate of interest that doesn’t even recoup losses from inflation.

Such a negative real interest rate environment is what makes gold rise. For several reasons.

The gold price tends to rise with inflation, so, when inflation is higher than interest rates, you might as well own gold instead of savings or bonds. You’re more likely to preserve your wealth.

Also, in such an environment, inflation is likely to continue rising as people borrow cheap money to buy things. That makes gold even better.

Inflate the debt away

Why am I laying this out so carefully? Because I’m expecting a prolonged period of negative real interest rates. Inflation will be above interest rates, perhaps for decades to come.


When governments have too much debt, they must make tough choices.

They can try and repay that debt by cutting spending and raising taxes — the austerity that is politically problematic.

Or they can print money and inflate away the debt by making the money it is measured in worth less.

There is one weakness in this plan.

Given interest rates can rise, and do rise when inflation occurs, surely inflating away debt doesn’t work?

As soon as people realise inflation is coming, they’ll demand more interest to invest in bonds. And central bankers will raise interest rates to keep inflation in check. In other words, the financial world will simply adjust to the higher inflation, making it impossible for the government to inflate away the debt.

Well, and this is the key point I’m making, under the cover of COVID-19, governments and central banks have taken control of interest rates more broadly than before.

They now influence both short-term interest rates, and long-term ones, under what they call ‘yield curve control’.

They have also begun interfering in commercial bank lending with guarantees, nationalisations, bailouts and demands that companies which accept rescues do the politician’s bidding, such as cutting dividends and buybacks. Banks were effectively forced to lend in many countries.

We have entered an age where politicians have grabbed the power they need in order to engineer an inflation which actually does inflate away political debt.

By controlling the coping mechanisms with which economies have to deal with inflation.

The money you have saved and invested will be the collateral damage.

And that’s why gold is moving now — in anticipation of the attempt to inflate away government debt while also keeping interest rates low.

This combination means inflation will rise far above interest rates, which means negative real rates and a surging gold price.

Our gains in the gold price and gold stocks may seem like good news. But, this week, my message is a reminder that we own those assets based on a pessimism of what’s in our future.

Protecting your wealth during a crisis is great. But there’s still a crisis out there…and it is becoming increasingly obvious that this crisis is an inflationary one.

Until next time,

Nick Hubble Signature

Nick Hubble,
For The Daily Reckoning Australia

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