Quantitative Easing and Gold

The policy of quantitative easing (QE) affects almost every single market in the world. The modern day financial markets are so interconnected that a change in one market is definitely reflected in the other markets too. Hence, along with bond and stock markets, quantitative easing (QE) creates waves in the gold market too. To many, this may seem to be surprising as to what does a precious metal like gold have to do with government policies! Well, it turns out that gold and government policy has been around for centuries. The effect of quantitative easing (QE) is therefore only one of the latest of many government policies which have affected the gold market. In this article, we will try and explain the link between gold and fiat money as well as how quantitative easing (QE) affects both of them.

Gold Vs Paper Money

The modern monetary system is actually a competition between paper money and gold which was the money of ancient times. Earlier money used to be printed only if there was sufficient gold in reserve to be able to print that money. However, the world has moved to a fiat money system in the 1970’s when President Nixon took the world off the gold standard. Hence, there is a direct competition between paper money assets and real assets such as gold. Therefore when the demand for one goes up, the demand for the other goes down and so their prices move inversely as well because of this competition.

This up and down movement of gold and fiat currency has been further exaggerated by the quantitative easing (QE) policies being followed by the current United States government. The government artificially manipulates the money supply in the system. Therefore, it also implicitly manipulates the value and price of gold.

In this article, we will have a closer look at how the policy of quantitative easing (QE) affects the price of gold in the system.

Gold and Crisis

Gold has always been considered to be the real money by conservative investors worldwide. This is because whenever the fiat money system completely breaks down gold is what the monetary system automatically resorts to. This is what has happened in countries like Zimbabwe when the system completely collapsed. Hence, whenever, there is speculation regarding the breakdown of the monetary system due to hyperinflation, gold prices will move in the upwards direction. This is what happened when the subprime mortgage bubble burst in 2008. There was fear that the entire economy will go under and therefore the investors rushed to buy as much gold as they possibly could.

Hence the demand for gold increases during crisis. It is widely believed that the current standards of quantitative easing (QE) will end up in a crisis situation. This is because the current standards of quantitative easing (QE) cannot be sustained. Hence, the demand for gold as well as the price for gold is expected to skyrocket in the near future as and when quantitative easing (QE) tapering begins.

Excess Money and Gold

Excess money in the system makes it appear that the price of gold is actually rising. In reality this is not the case. Consider the fact that a rising tide raises all ships. Therefore, when the Fed creates new money and injects it into the system, the prices of everything go up. However, the prices of gold go up comparatively less than the prices of other paper assets like stocks and bonds.

Hence it appears as if the prices of gold are increasing in nominal terms. However, when we consider the same in real terms i.e. in comparison to other assets, the price of gold usually declines in a period when excessive quantitative easing takes place.

Quantitative Easing (QE) Tapering and Gold

The mere news of a quantitative easing (QE) tapering brings shockwaves to the gold market. In the recent past, whenever the Fed has so much as hinted towards using the policy of quantitative easing (QE) tapering, the prices of gold have skyrocketed overnight.

This is because quantitative easing (QE) tapering means that the Fed will stop the excess money creation that it is doing now. Hence, there will be fewer dollars in the system chasing the same amount of gold. Fewer dollars would imply that the real value of gold will rise much faster than the nominal value. Hence, quantitative easing (QE) tapering makes it look like gold as an asset class is appreciating in terms of nominal value. However, the actual appreciation comes in terms of real value.

There have also been rumors that Central Banks around the world have been leasing out gold in the markets. As such they may not have possession of the amount of gold on hand as they claim to do. Therefore, the markets may be hit by a double whammy of contraction in the money supply and sudden perceived shortage of the amount of gold in the world. This double whammy may be enough to spike the price of gold to historic levels.

There are some conservative investors like Peter Schiff who believe that gold is the future and that one must invest as much in gold as they possibly can. Their views are further supported by how the markets react to the quantitative easing (QE) tapering policies.