If the last few weeks are any indication, central banks will stop at nothing to ensure that the economies of the world are able to recover from COVID-19 and the lockdown it has forced upon billions of people worldwide.
This includes traditional methods such as zero interest rate policies (ZIRP), cutting interest rates back down to post-financial crisis lows of almost zero per cent. The idea behind ZIRP is to bring down the cost of borrowing to such a low point that it becomes virtually impossible to save, so borrowing becomes the only possible alternative.
But as rates drop close to zero (or even below in some cases), more unconventional methods are also being used, which could suggest that a period of currency weakness is upon us. Gold could benefit from this enormously. Could we be on the verge of a new unofficial gold standard?
Printing money to cushion the economy
Much like the US Federal Reserve (or Fed for short) and the ECB, the Eurozone’s very own central bank, the Bank of England (BoE) has adopted a policy tool called quantitative easing (QE) in order to stimulate the economy. It will digitally create £200 billion, cutting interest rates to 0.1 per cent. For now, policy makers seem reluctant to take the UK into negative-interest rate territory (otherwise known as NIRP).
QE involves the digital creation of money, which is to be used to purchase government bonds in order to keep long-term interest rates low and spur some form of recovery. More currency sloshing around an economy, however, has the consequence of devaluing each unit thereof. This fundamental law of economics means that currencies such as the pound and the US dollar could be under intense pressure and even devalue if such a policy continues unabated.
Gold could benefit enormously from a fresh round of money printing. This was certainly true in both 2008 and 2011, when central banks simultaneously launched a coordinated round of QE. The stimulus that ultimately prompted gold’s last decade-long bull run to come to a brief stop was the prospect of rate rises in 2013. Anyone looking at the immediate economic impact of COVID-19 so far will know that rate hikes from the BoE, the Fed or even the ECB are a remote prospect, to say the least.
Much of the UK gold market’s price action is heavily influenced by the performance of sterling. All it takes is a sudden devaluation, combined with turbulence in US markets, and the seeds are sown for an explosive price rally in gold.
Gold reserves are the key
If gold is poised to explode to the upside, at least in pound sterling terms, this marks the arguable beginning of a new gold standard. If the value of your currency must fall by a certain amount to account for weak economic growth and rapid currency creation via QE, gold must step in as a safe haven to preserve the value of your wealth by making an equal and opposite rise in value.
Unfortunately for the UK, the BoE holds much less gold in reserve than when the Bretton Woods system was created in the 1940s. Former Chancellor Gordon Brown famously sold much of the UK’s gold reserves during a secular low for gold in 1999, infamously referred to as Brown’s Bottom for years to come.
Countries such as the Russian Federation, on the other hand, could stand to gain from a soaring gold price. In recent days, reports from Reuters have pointed to significant shifts when it comes to stocking up on gold. The Russian Government is understood to have been requesting the Central Bank of Russia (CBR) to do what it can to resume accumulation of gold reserves, despite a recent pause owing to supply constraints. It is estimated that the CBR now holds reserves of 73.6 million troy ounces, estimated to be worth up to $120 billion.
In a new era, during which the strength of economies would be correlated to the amount of gold they have on reserve, countries such as the Russian Federation could stand to gain much, especially after having taken measures to limit exposure to US treasuries.
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