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Coronavirus recovery: gold price spike shows real fear of inflation

04 August 2020


Inflation is always and everywhere a monetary phenomenon,” the Nobel Prize-winning economist Milton Friedman wrote in 1970. With central banks firing up the printing presses in their response to the Covid-19 pandemic, global money supply is increasing rapidly and markets have noticed. As there’s always a risk such monetary largesse results in price inflation, markets are factoring that into their calculations. The price of gold

has soared, hitting an all-time high last week of US$1,980.57 an ounce.That represented a nearly 30 per cent increase in the gold price in 2020. The rise has occurred despite clear evidence coronavirus-related economic lockdowns in countries such as China and India – both key gold consumers – has hit retail demand for gold. Gold consumption in China, which is the world’s largest producer and user of the metal, contracted by 38 per cent in the first half of 2020, according to the China Gold Association.


Gold usage in jewellery, which makes up some two-thirds of gold used in China, shrank 42 per cent in the first half of the year. Consumer expenditure on gold coins and bars, more generally for collection or investment purposes, plummeted by 32 per cent. Even so, the gold price keeps rising.No doubt the uncertainty surrounding the pandemic is a key driver of gold demand, the precious metal having been a safe-haven asset for millennia. However, there is also the possibility that central bank policy responses to the pandemic, while perfectly logical in the current context, will have consequences that will appear undesirable in time.Yield suppression by banks in their attempts to keep the supply of credit inexpensive and plentiful during the pandemic have made it more economical to hold non-yielding assets such as precious metals. When suppression drives nominal yields below existing inflation rates and puts real yields into negative territory – as is presently the case in the United States – the argument for holding gold and other precious metals becomes easier to construct.


It is the increase in money supply as the world’s central banks turbocharge their printing presses

, however, that arguably deserves the most attention. Dutch bank ING noted last week that US “money supply has grown at unprecedented levels over the last few months” with Federal Reserve data showing that “over June, M2 money supply grew by 22.9 per cent year on year”. That far exceeded the 10 per cent year on year growth seen over stages of 2011 when spot gold hit the previous record high.This is not just a US phenomenon. ING also noted there has also been “significant growth in money supply” in the euro zone “with M2 supply growing by 9.1 per cent year on year in May, levels last seen in 2008”.China is not immune, either. Data last month from the People’s Bank of China showed Chinese M2 money supply rose 11.1 per cent year on year in June.


Admittedly, the velocity of money – effectively the rate of turnover in the money supply – is slow. As ING wrote, the latest data from the St Louis Federal Reserve shows the velocity of US M2 money supply lower than it has ever been, in a sequence of data that goes all the way back to 1960.As difficult as it seems to imagine at the moment, this global health emergency will ease eventually. When it does, consumer activity will normalise and there likely will be a material uptick in the velocity of money alongside the already marked expansion of the money supply


. That would be a recipe for inflation.

Additionally, just because money supply expansion during the 2008 financial crisis failed to generate marked price inflation does not mean it won’t this time round.Back then, central bank money printing effectively replaced money that was lost on strategies that had gone badly wrong. In this pandemic, firing up the printing presses is primarily intended to physically increase the money supply in the real economy.Central banks these days pay far less attention to Friedman’s monetarist theories than in the past, but that does not mean those theories are irrelevant. Friedman published “There’s No Such Thing as a Free Lunch” in 1975, and there still isn’t.


The soaring gold price

isn’t unjustified. Printing money to help the real economy cope with Covid-19 could yet generate price inflation.