Glitter of Gold,
They went up by 8.2% from March 9 to March 24. 59,545 calories per gram In contrast, a savings account pays between 3 and 4 percent annually, and the majority of one-year fixed deposits currently pay around 7 percent. Naturally, these are returns that are certain, whereas gold returns are not.
Besides, the ascent in gold costs has led to a few stories in the media that pose the supposed inquiry – is this the ideal opportunity to put resources into gold? The problem is that this is not an easy question to answer with a straightforward yes or no. In fact, there is no way to answer this question without first comprehending how the financial system actually functions, the instabilities that cause it, and how they affect the price of gold.
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This month, the world learned that a few small and medium-sized American banks are having financial difficulties. A large Swiss bank, Credit Suisse, was saved simultaneously by its rival, UBS. There is a possibility that the infection will also spread to other banks. These difficulties mirror the shakiness of the monetary framework as it exists in a large part of the rich-world.
As a result, money has become gold, and over the past few weeks, its value has increased. When something goes wrong with the financial system, gold has been viewed as a safe haven where money flows quickly for centuries. How did we get here this time? That’s the question.
Fed’s wrong bet
solutions have consequences
As of December 2020, the total deposits with commercial banks in the US stood at $16.1 trillion. As the Fed printed money and the government deposited some of that money into people’s bank accounts, the deposits grew exponentially. By mid-April, 2022, they stood at $18.1 trillion.
Banks lend money to people by giving loans. They also invest in bonds. As of December 2020, commercial banks in the US held approximately $3 trillion in Treasury bonds and agency securities. Treasury bonds are issued by the US government to finance its fiscal deficit, or the difference between what it earns and what it spends. Agency securities are financial securities typically issued by an enterprise sponsored by the US government.
As the printed money trickled down to commercial banks, their investment in Treasury bonds and agency securities grew rapidly, touching a high of $4.7 trillion by February 2022, a 57% jump from December 2020.
Now interest rates and bond prices are inversely proportional. Therefore, if interest rates rise, bond prices fall. Also, the longer the term of a bond, the greater the drop in bond prices when interest rates rise. That’s exactly what happened.
As the Federal Reserve raised interest rates to control inflation, the prices of bonds held by commercial banks fell. By December 2022, the unrealized losses of these investments stood at $620 billion. These losses were unrealized because the bonds were on the books of the banks and had not been sold.
Banks borrow through deposits for short term and lend for long term. Therefore, as deposits mature, banks need money to pay them off. This dynamic forced some banks to sell some bonds in order to pay depositors.
One such bank was Silicon Valley Bank. In doing so, he incurred a loss of about $1.8 billion. On March 8, it tried to fill the gap by selling $1.75 billion worth of new shares. This worried the investors who had invested in the bank’s stock. They sold out and the price dropped. The news spread on social media, leading to bank runs, where people started withdrawing their deposits from the bank. Soon, other banks such as Signature Bank and First Republic Bank were in trouble, forcing the Federal Reserve to step in and prevent the situation from getting worse. In fact, a Reuters news report suggests that estimates by analysts at JPMorgan Chase & Co suggest that in March, some $500 billion was withdrawn from vulnerable US banks following the collapse of Silicon Valley Bank.
Along with these American banks, Credit Suisse is also in trouble. According to a recent Reuters article: “A series of scandals over several years, changes in top management, multibillion-dollar losses and an indifferent strategy can be blamed for the mess.” In fact, in the three-month period ending December 2022, the bank posted a loss of $1.5 billion. More importantly, customers took out about $121 billion from the bank during this period. This created a danger of spreading the infection. Deutsche Bank shares fell on Friday.
The volatility thus created has pushed up the price of gold, rising 8.1% in dollar terms between March 9 and March 24.
What are your thoughts on the future?
When Lehman Brothers, the fourth-largest Wall Street investment bank, went bust in September 2008, the Federal Reserve started printing money to save other large financial institutions. The economy’s short-term interest rates will be set by the Federal Reserve until that occurs. After two years of the financial crisis, however, this did not much change.
In his book The Lords of Easy Money, Christopher Leonard states: The Fed was no longer merely attempting to regulate short-term interest rates. It was attempting to boost the US economy as a whole.” To lower long-term interest rates, it did this by printing money and flooding the financial system. Quantitative easing was the technical term for this.
This was done in the hope that as long-term interest rates fell, people would borrow more money and spend more, and businesses would borrow more money and invest more. This would help create jobs and boost the economy’s slow growth.
This recipe was before long followed by other national banks in the rich world. In The Price of Time, Edward Chancellor writes: The Federal Reserve implemented quantitative easing in November 2008, followed by the Bank of England in March 2009, the Bank of Japan in August 2011, the European Central Bank in January 2015, and the Swedish Riksbank in February 2015.
The rich central banks of the world reverted to quantitative easing when the Covid pandemic struck at the beginning of 2020. Given that Main Street is about to be saved in 2020, Wall Street was saved in 2008.
Satyajit Das, a previous financier and creator of A Dinner of Results – Reloaded, says: ” It’s possible that the global economy is currently stuck in a cycle of easy money for ever. When central banks have grown accustomed to the idea of printing money in the economy, they are now in trouble. That won’t change anytime soon either.
While it is simple for central banks to initiate quantitative easing, it is extremely challenging for them to withdraw it. Additionally, it merits recollecting that quantitative facilitating or cash printing makes side impacts. Inflation has recently been one. Deposits have been withdrawn as a result of higher interest rates and significant losses on the balance sheets of small and medium-sized US banks.
As a matter of fact, since mid-April 2022, the Central bank has been gradually taking out the cash it has printed and siphoned into the monetary framework throughout the long term. It had managed to withdraw close to $623 billion up until March 8. It had to print $391 billion between March 8 and March 22 in order to lend money to American banks affected by the crisis.
The lesson here is that the US and global financial system will continue to destabilize in unpredictable ways as long as easy money does not arrive. Das puts it this way: When there is a problem, easy money is seen as a solution because it is convenient.
As a result, it makes perfect sense to always have some money invested in gold because it is regarded as a safe haven where quick cash can be obtained in times of need. Naturally, the right ratio is determined by the investor’s risk tolerance.
Gold: The India Story
Take a look at the first and second pictures. From January 1, 2006, the price of 10 grams of gold in rupees is shown. One troy ounce of gold, or 31.1 grams, is shown here for $2.
In point of fact, the annualized return of gold in rupee terms over the 17-year period depicted in Figures 1 and 2 is roughly 12.3% per year. This amounts to approximately 7.5% annually in dollars.
This is because dollars are used to buy and sell gold around the world. It is traded in rupees in India. Gold returns in rupees have been higher than in dollars due to the rupee’s depreciation against the dollar over time. was about 45 cents at the beginning of 2006. It now costs 82 a little more. In rupee terms, this depreciation results in higher returns. Thus, the devaluation of the rupee stays one more motivation to hold gold in the speculation portfolio.
Interestingly, for the same time period, the annualized return of the Nifty Total Returns Index, which is a good indicator of the average return on stock investments, was 12.3%.
Obviously, on the off chance that somebody had purchased gold after the monetary emergency in late 2012 or mid 2013, when it was worth very much in dollar terms and around when pain free income in the worldwide monetary framework topped, they Would have given basically no return in dollars. The annual return in rupees would have been 7.3%.
As a result, gold should not be considered merely a personal investment; rather, it is a play on the global financial system’s abundance of easy money. It ought to always be a component of an extensive portfolio.
Terrible Cash is composed by Vivek Kaul.
Disclosure: Gold ETFs and mutual funds are held by the author.
