Money for the next world
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Storing wealth in assets gives a return so that we can also call it an investment. For an investment in asset, we can have a periodic return in terms of interests or dividends or otherwise, and a capital gain in terms of increased value of the asset.
World of gold
When the world economy is nearing its end of the business cycle, investors tend to buy gold. We would see that people start shifting their investment from other assets to gold. Look at it from the flip side: If you notice that the demand for gold is rising in the world, you should know that the end of the world economy is closer! It’s because gold is worth in the next world as well as in this world. Let me elaborate the point.
Since ancient times, gold has been playing a central role in the economic world as a “medium of exchange” as well as a “store of value”. During medieval times, a nation’s economic power was measured in terms of the stock of gold accumulation.
The world abandoned gold as a medium of exchange in 1944. But it continued to remain a “store of value” to-date. Not only the private investors, but also the central banks all over the world use gold as part of their stock of foreign reserves. The largest stock of gold reserves which amounts to over 8000 metric tonnes is with the US, while it accounts for more than three-fourth of the country’s official foreign reserves. Therefore gold price movements in the US are important for the gold market in the entire world.
However about 50 per cent of the world demand for gold is for jewellery. When the income levels of the biggest buyers of gold jewellery – particularly India and China -, grow, then it also makes a difference to world gold demand and prices. Gold demand for investment accounts for about 40 per cent, which is directly relevant to our discussion today. The balance 10 per cent of the demand comes from the manufacturing industries, which use gold as a raw material.
Gold rush
Investment demand for gold usually moves in line with ups and downs in the world economy – the so-called business cycles. During the “good” times, usually gold prices should decline, because investors start moving from the gold market to lucrative bond and stock markets.
During “bad” times of the world economy, gold prices should rise as investors move in the opposite directions. Investment in gold is safe during economic downturns at which investment in other assets such as bonds and stocks is bound to lose.
The investors who do their usual business cycle calculations foresaw the approaching global financial crisis in 2008, and started shifting their investment from bonds and stocks to gold. This raised the demand for gold and pushed up the gold prices in the world prior to the financial crisis.
In 2001, a gold ounce was less than US$400 in New York, but it increased gradually to over $1,000 by 2008. As the “gold rush” mounted, within the next three years gold prices doubled reaching a historically high price of $2,000 per ounce by 2011. When the big fellows move their investment to gold, millions of smaller fellows panic and follow suit. It created chaos in the currency markets, stock markets, and bond markets which collapsed as gold markets were sky-rocketing.
An item in the shape of a cricket ball studded with precious stones and gold, displayed a few years ago at a local jewellery show.
The increase in gold prices prior to an economic crisis has been a typical scenario all the time in world history. Before the Great Depression in the 1930s, gold prices started to rise. Before the world entered into a “stagflation” (stagnation plus inflation) in 1973, gold prices started to rise.
In contrast, as the world economy started to expand after the World War II, gold prices continued to decline until the early 1970s. In the 1980s and the 1990s too, gold prices continued to decline until the turn of the century.
And if gold prices are rising in the world, then we should take a serious note about it. If the upward trend in gold prices is a result of shifting investments from other assets to gold, then the end of an economic cycle is just around the corner. The irony is that the shift in investment itself makes the recessions faster and the end of the cycle closer.
Present “end times”
Gold prices started to rise again during the recent past: Four years ago by the end of 2015, a gold ounce was about $1,000. One year ago by the end of 2018, it was $1,300. Now at the end of 2019, it is $1,500. Are the investors moving their investment into the gold market again?
When there is an excessive money growth particularly in the hands of “speculative investors,” then it is a driving force behind investment demand for gold as well as for other assets. This is where we find the roots of the current problem.
Money has been growing much faster than the real economies, driving the interest rates down even to negative figures. “Quantitative easing” is the new monetary policy motto for the advanced countries, because even their conventional monetary easing became ineffective. The rich countries such as the US, Japan and the Euro zone which have been experiencing slower growth since the time of the global financial crisis has been injecting money to stimulate growth.
In spite of recent fund rate hikes in the US to around 2 per cent, the interest rates in the US remains historically low in the recent past at around 1 per cent. The average interest rate in the Euro area continued to remain at zero per cent over the past few years. Japan has driven its interest rates down to negative figures.
Economics upside-down
The typical economics principles appear to be upside-down now: When we have excessive money we should expect inflation, but there is no inflation. When we have cheap credit, we should expect more spending – spending for both consumption and production, which would stimulate growth. But there is no growth stimulus either.
The irony is that with excessive money, borrowing is “rewarded” and saving has a “cost”. As a result of mounting money stocks, private credit has expanded in billions and trillions a year. The question is that where did that money go, if it didn’t stimulate consumption and investment. They did go to asset markets – stocks, bonds, and gold. It was, indeed, a lucrative business to borrow at low or negative rates with a “reward” and investment in assets, driving the asset prices up in the world.
The problem was that it cannot continue forever, without a decline in debt quality. The global corporate bond market has experienced falling credit worthiness along with the increase in the money stock. This means that the world economy is moving towards a “high risk” zone.
Then, where is the safe haven for investors who would perceive that the world is approaching towards another financial crisis? It’s gold so then let’s move into gold which would protect our wealth in this world as well as in the next world after the crisis.
By the way, there is a silver lining in the dark clouds, even for the countries which do not have much investment in gold: There are accelerated capital outflows from economic recessions in the form of foreign direct investment. The countries that are prepared to capitalise on this will start accommodating the capital outflows and achieving higher growth.
(The writer is a Professor of Economics at the University of Colombo and can be reached at sirimal@econ.cmb.ac.lk).