- Inflation can explode and real interests fall further with the crisis.
- But in the short and middle term, also deflation is possible.
- Central banks will make whatever it takes to generate inflation.
- Gold investment is a classic inflation hedge, the gold price may explode.
- Gold price surged already, silver and platinum can follow.
The title of this post may appear exaggerated, but it is realistic. We live in extraordinary times and that will cause exceptional changes in economic conditions and asset prices. Let’s see the three elements in the headline. Is the coronavirus-crisis causing an epic inflation pressure? Should we expect a horrific negative real interest? And are we facing a further brutal gold price jump?
1st Part: Is the Coronavirus-Crisis Causing Epic Inflation?
The inflation (Consumer Price Index, CPI) was historically low or moderate in the last years, in most countries of the globe. The coronavirus crisis – which can be the largest depression of the last 100 or more years – can change that. How?
Inflation is when prices of products and services are surging on average. The price of a typical consumer’s goods and services basket is increasing. “John Doe”, the regular consumer, receives less for his same money. Let’s see what causes inflation.
The Main Causes of Inflation
It occurs when consumer demand for goods and services increases so much that it surpasses supply. There can be various reasons for it, “over-expansion of the money supply” is one of them. That expansion, “easing” is happening today. The US Federal Reserve and other national banks are trying to rescue economies with more money supply.
This can happen through higher wages, currency devaluation, elevated taxes. But also “natural disasters create temporary cost-push inflation by damaging production facilities” – wrote The Balance. We can surely consider the epidemic as a natural disaster, where a significant part of the production has already been lost. (Sources: The Balance, EconomicsHelp)
Factors That Lessen Inflation
But some elements in this crisis work against higher inflation. Demand is falling for many reasons. Many people are losing their jobs and their income. Others are reducing their consumption to be prepared for harder times. Many others need not spend much in the quarantine. Companies in trouble may sell their products at lower prices, price wars can be more intense.
You may also remember that central banks are “easing” for more than a decade already. They are often cutting interest rates, buying bonds and pumping money into the economies. Since the last crisis in 2008-2009 approximately. But these easing measures didn’t cause considerable inflation since then. Rather, the main success for them was that inflation did not sink even deeper.
Good Inflation and Bad Deflation
High inflation, like 6-10 percent or more p. a. is harmful in the economy. Or at least a bad sign of illness, like a fever. At the same time, some moderate inflation, 2-4 percent a year, is acknowledged as healthy by most economists. But deflation – negative inflation, falling prices – is a nightmare of the central banks and governments, and for all of us. It can last very long and has a hard, devastating effect. A kind of death spiral can start: the lower the prices, the deeper the crisis. More and more companies are in trouble and selling goods even lower, or going bankrupt. (You can read more about it on Investopedia)
We mentioned that the “expansion of the money supply”, central banks printing money at a sped-up pace, is inflationary. But central banks have other measures ready, like sterilization. That means, they can retire earlier emitted money from the circulation, from our economy. So they can milder the inflationary effect of the money oversupply. But history teaches us something important. Once the genie (djinn) of inflation has been let out of the magic lamp, it is very difficult to push it back there. Inflation is often very difficult to milder. There were many examples in the 70s, 80s, 90s.
The Incredible Turn in Economic Policy
Policymakers know the danger of deflation, so they will make everything, “whatever it takes” to stop a similar process. They will try to cure the crisis with inflation. With even more central bank easing. They began that already. But the measures taken before may prove insufficient. Nobody will consume more in the quarantine because interests are lower. Or because central banks are buying shares on the stock exchanges. What central banks are usually doing – the monetary policy – is not enough anymore.
The Fed promised essentially unlimited liquidity for the government and corporations alike. These unprecedented measures will likely require trillions of dollars to be introduced into the financial system.
(SeekingAlpha, Victor Dergunov)
Now, and that is a huge shift in economic policy, a new powerful force, the governments must intervene. (The “fiscal policy”.) They will also spend trillions of dollars. That means thousands of billions or millions of millions of dollars. US-president Donald Trump already sent a check of $1,200 for most people in his country. He is putting money directly into the pocket of citizens. (Unusual by conservative political parties.) Other countries are lowering taxes or completing wages in some industries, rescuing jobs and companies. The era of “helicopter money” is here. That means governments are donating money to the people, just to consume. (As if scattered from a helicopter among the people.)
Spain’s government says it will pay tens of thousands of the country’s lowest-income households a “minimum living wage”, starting in May. Because of the massive job losses triggered by pandemic lockdowns. (Bloomberg) Discussions about an “unconditional basic income” are on the table in other countries. This “helicopter money”, an unconditional money gift for the consumers, can be regular. And that is sure an inflationary factor which can balance the effect of falling wages.
Summary 1: Inflation Is Coming
Yes, more inflation is on its way. Not a “hyperinflation” like in some wars or dictatorships, but a higher one than today. There are also anti-inflationary effects in the economy. So, more inflation can happen, perhaps only later, in some years. It can get a big problem for investors and savers.
2nd Part: Should We Expect a Horrific Real Interest?
The real interest is the interest minus the inflation. For example, if we have two percent inflation and the interest is three percent, we receive one percent real interest. We can buy one percent more with our money. But if interest is only one percent, we have a one percent negative real interest rate. That means, in a year, we can buy one percent fewer products and services, on average. (See also our post: Eight Ways How Inflation Threatens Your Income, and 13 Ways to Fight It)
Forget Real Interests!
And now rather forget positive real interests! You will not reach a positive real interest rate in the coming years. (In developed countries.) This is because states will aim to inflate their debts. Paying a negative interest rate for their bonds, treasury bills. As described in the first part, states are pouring huge sums into the economy. This is only possible with even more debt, or money printing.
After that, they can only repay the debts if they pay low interests, below inflation. Central banks may not do anything but keep interest rates very low. Otherwise, they could start a wave of sovereign defaults (state bankruptcies) and corporate insolvencies. Also mortgage loans, consumer credits would be a huge problem.
Do We Have Another Choice?
What is happening by negative real interest rates is, states are taking away a part of savers’ wealth to cover their expenses. This is theft – may some readers think. But, what other choice do they have? Leave tens of millions of people unemployed and without an income? Leave hundreds of thousands of smaller and larger businesses collapse and fire their employees? (Lift pandemics restrictions early and kill, perhaps, hundreds of thousands of elderly and ill, endangered people?)
There are only three ways to repay government debts. First, the hard way. Repaying it at all costs, with taxation, spending cuts, austerity. But that would also people pay for. It’s the taxpayer’s money. The second method is to declare state bankruptcy. Here, creditors, bondholders would suffer. (But also small investors, savers, or their retirement funds, for example.) And nobody would buy government debt anymore. The third method is inflating the debt, as mentioned before. In the short term, less painful than the first two.
Inflating debt is not unprecedented, nothing new. For example, this happened with debts accumulated in the United States during World War II. This has been also the case in recent years in the EU, the USA or in Japan. Many countries had real interest rates mostly in negative territory in the last decade.
Are We Heading to the Modern Monetary Theory?
Modern Monetary Theory is “a macroeconomic theory and practice (…) advocates argue that the government could use fiscal policy to achieve full employment, creating new money to fund government purchases. According to advocates, the primary risk once the economy reaches full employment is inflation, which can be addressed by raising and gathering taxes and issuing bonds to reduce money and the velocity of money in the system. (…) These tenets challenge the mainstream economics view that government spending is funded by taxes and debt issuance.”
Summary 2: Negative Real Interest Rates
Because of the crisis, debts will continue to rise. Or rather jump, explode. The fundamental interest of states and central banks in the coming years, perhaps decades, is to maintain a deeply negative real interest rate. Because this can inflate debts, which is perhaps the least painful way to solve the approaching debt problem.
3rd Part: Are We Facing a Brutal Gold Price Explosion?
What can protect us, small investors, savers from the devastating effects of negative real interest rates? Short answer: Real assets. Real or physical assets “include precious metals, commodities, real estate, agricultural land, machinery, and oil” – wrote Investopedia. Equities, stocks may not count as real assets by definition but are also a good hedge against inflation. Companies can raise their prices and generate inflation-generated profits. Stock prices and dividends can include this profit. But back to the gold price and gold investment. Let’s make a list about what makes gold – and other precious metals – more precious.
These Main Factors Can Push Gold Price Higher
Negative real interest rates
…as a result of inflation and low interests, managed by central banks. People buy precious metals if their money on bank accounts, or in bonds loses its value. (Gold is an “inflation hedge” asset.) In the coming years, real interest rates may be very low and severely negative. We wrote about this in part 1 and 2.
Longer uncertainty, instability, turmoil
…in the capital markets, like stocks, bonds, commodities, foreign exchange prices. (Gold has a “safe harbor” function.) Markets were extremely unstable, volatile in March and the first half of April. At the time of writing, there are some positive signs but no real solution to the crisis yet.
Demand for physical gold investment,
…like jewelry, bullions or coins. In crisis times, some investors are hoarding physical metals. But demand for jewelry may fall in this period. (People have less money to spend on luxury goods.) By newer data, gold and silver bullions and coins are high in demand in the coronavirus crisis.
The industry-driven demand may fall in crisis times, but this demand is traditionally low by gold. Much more important with silver, platinum, and palladium.
Central bank buying
Central bank “gold reserves survey 2019“points to continued robust central bank demand for gold in the short and medium term” – wrote Centralbankgold.org.
On this list, four of the five factors turned positive for gold investment in the last months, or before. But the most important could be the first one, central bank policy and the real interest rate. Gold began to surge in May 2019, weeks after the US Fed and other central banks turned dovish. (Eased monetary conditions, again.) It is 33 percent higher now, in the middle of April 2020 than 12 months before. (Chart 2, 4.)
How Silver and Gold Price Jumped after the Last Crisis
Gold is a rare metal, many mines are already depleted. The production isn’t flexible. Gold miners can’t add much to supply. And the price is, like by most exchange-traded products, often sentiment-driven. Sometimes the expectations, the projections move the price. For example, the news about a big investment bank publishing a new prognosis. The price of gold can fluctuate similar to that of stocks or stock indices.
Supply, demand, and investor behavior are key drivers of gold prices. Gold is often used to hedge inflation because, unlike paper money, since its supply doesn’t change much year to year. (…) Since gold often moves higher when economic conditions worsen, it is viewed as an efficient tool for diversifying a portfolio.
In the last crisis of 2008-2009, gold price, but also silver and platinum fell first, due to lack of liquidity on the markets. Some months later, these metals rose and peaked much higher in two-three years. Gold jumped approximately 200 percent. And silver, 500 percent from the bottom to the top. (Sixfold price, to $49 from $8.0-$8.5 roughly.) Silver stays often behind gold but is much more volatile. The gray metal had lower bottoms but much higher peaks in the past. (An interesting post about why the silver price could explode on Zerohedge).
A Good Gold Investment Alternative: Miners’ Stocks
Now, silver and gold in 2020. We see a very similar pattern as in 2008. First prices fell. Silver, like stone, almost like the stock indices. Later, with liquidity measures taken by the central banks, prices recovered. We will see if in 2020, or in the next years, the big precious metals bull market of 2008-2011 can come back.
Some investors are buying gold miners’ stocks instead of the metal itself. Miners have the advantage to pay dividends. Gold miners’ stocks can be more volatile than the gold price. (There is a leverage effect.) It is common that one percent of gold price surge causes a 2-3 percent jump in miners stocks. Investors can buy ETFs (exchange-traded funds) like the GDX, or other products following indexes. For example, the Arca Gold Bugs index (HUI) or the NYSE Arca Gold Miners GTR (GDMTR) index.
Main Summary: Gold Price, Silver May Jump
The gold price can jump, in my opinion, and in the opinion of other authors, analysts. But, of course, no one can guarantee that. (Read the disclaimer.) What we know almost for sure is, central banks will make whatever it takes to prevent deflation and generate inflation. Real interest can fall further to deeper negative territories with this crisis. But in the short or middle term, also deflation is possible. As gold investment is a classic inflation hedge, the gold price may surge a lot, again. Silver and platinum may follow.
More Important Readings for You About Your Money
- How to Buy Cheap Stocks in the Coronavirus-crash?
- Crude Oil Buy Is an Extremely Dangerous Play
- 9 Essential Ways to Prevent Investment Scam
- 6 Effective and Proven Ways to Lose Your Money
- Eight Ways How Inflation Threatens Your Income and 13 Ways to Fight It
I’m not a certified financial advisor nor a certified financial analyst, accountant nor lawyer. The contents on my site and in my posts are for informational and entertainment purposes and reflecting my collection of data, ideas, opinions. Please, make your proper research or consult your advisors before making any investment or financial or legal decisions.
I have open positions in silver (long), platinum (long), global energy stocks (long) and crude oil (short) at the time of writing.
(Photos if not marked otherwise: Pixabay.com.)
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