Too often do we talk about how our economies effect gold prices, and not the other way around. You see, while market movements have a clear impact on gold prices, by way of investor sentiments, the opposite is true. Since time immemorial, a reflexive reaction to changes in demand for gold has effected the economy. To understand how do gold prices effect the economy, we need to touch on some history and theory.
Most importantly, I am going to talk about how human psychology creates a sort-of feedback loop between our economy and the price of gold.
First, Why Would You Look Into How Gold Prices Effect the Economy?
Whether you are an investor, collector, or just interested in the subject, it is essential to have a 360-degree picture of precious metals. What you probably know is that as it gets more expensive to buy gold bullion bars and stocks, other investments begin to look less attractive. The traditional explanation is that gold rises because these are less attractive. But is that it? Unlikely. The fact of the matter is that while signs of a poor economy can trigger market losses and eventually a run on the banks, a rising price of gold makes a strong contribution.
Think about it. In economics, the theory of reflexivity puts forth a sort-of feedback loop where a market reinforces itself. What appears to be a lollapalooza of catastrophic events may often be grossly exaggerated market sentiments. Still, is there more to how do gold prices effect the economy than a self-reinforcing market?
By understanding how do gold prices effect the economy, you can be better prepared for how quickly gold prices rise in response to sudden market movements. More importantly, you can stay informed on key market events and best hedge against sudden and long-term inflation.
Why Do People Buy Gold As a Hedge Against An Economic Crash?
Gold is a primal and psychologically irreplaceable currency. Especially for those who have come into its ownership, whether buying gold bullion or jewelry, the more expensive it becomes, the less comfortable we are. Many put money into gold and not stocks (whose yield rise with a sinking market) because they are afraid of losing their money. In other words, they typically buy precious metals as a hedge against investments such as stocks and shares, property or fiat currency crashing.
Yet, as the price of gold rises, people become increasingly fearful that they will not be able to buy their share. So what’s there to do? As governments become modern soothsayers, they are able to reignite our faith in paper money. In so doing, they expends massive financial and human resources that future generations will likely pay.
Gold Prices Have an Inverse Relationship to Economic Activity
A poor economy reduces investment demand and decreases revenues for companies. It may result in quantitative easing that dramatically lowers the value of fiat currencies. Yet, none of these scenarios seriously effects the usefulness of gold. Gold can’t go out of business due to poor sales. It can’t lose value due to a huge new supply being printed (or mined) out of nowhere. These are among the reasons why investors turn to gold when more traditional assets start to fall. This additional demand causes rising prices.
Obviously, there is a bit of a chicken and egg situation occurring here. Gold is widely known as a hedge against inflation. It’s relatively common knowledge that the price of gold rocketed during crises such as the second world war and the global market crash of 2008. The same happened during less infamous market crashes. Most recently, there was a spike in demand for gold following Great Britain’s decision to leave the European Union. Investors panicked about the prospect of a resulting market crash, and sovereign debt defaults.
The reliability of gold prices rises during economic uncertainty leads increasing demand, especially as cash becomes the alternative of choice. So far, we understand that rising gold prices are both the results of vicious economic circles, as well as the causes thereof. But why do they act as a cause?
That's where the gold standard and fiat currency comes in. One aspect of answering should we get back on the gold standard is that it would change the nature of downturns. Inasmuch as governments would lose much control of monetary policy, investors may be significantly more confident in long-term holdings.
Gold vs. the U.S Dollar
Gold prices are historically the most directly inverse to the value of the US dollar, as compared to other currencies or assets. This could be due to the United States' greater impact on global markets compared to other countries. Moreover, do Americans prefer more cash than other assets, and how are trends changing? Whatever the reason, the value of the US dollar versus other countries is a good indicator of the direction that gold is likely to go. There is also a relationship between bitcoin and gold, which is another interesting subject.
Gold vs Silver and Other Precious Metals
Gold's uses differ from that of silver and other metals, especially ferrous ones. Not only is gold significantly rarer, but it's uses are significantly less industrial in a traditional sense. Silver is historically cheaper than gold, and its price is typically more volatile. Nevertheless, a general rule, all precious metals are a historic hedge against economic crisis for the same reasons that gold is. When it comes to gold itself, there are nuances in the types of gold that are more expensive than others.
Gold's Real Value And How it Effects the Economy
The real value of gold has remained a relatively stable hedge against inflation for the last century and longer. Investors have long praised how an ounce of gold could buy you a high-quality suit, both in 1918 and 2018. Compare to what you can buy with the same amount of U.S dollars now and then, and you’ll see a perfect example of how gold protects against inflation.
Gold prices are such a reliable economic indicator and spike could potentially panic a small percentage of people into making economic decisions they wouldn’t otherwise do. While rare, this seemingly unlikely scenario has realistic impacts on gold prices could on the economy.