How Does Gold Affect the Economy?

It seems intuitive to think of the economy as affecting the price of gold. However, there is another side to the idea, with gold having a notable influence on domestic and global economies as various factors rise and fall. Learning more about how this economic effect plays out can help you become a smarter investor.

So how does gold affect the economy? To find the answers, let’s talk first about gold’s economic power in terms of history, price points, inflationary pressures, and investment options.

A Brief Background

Precious metals like gold have been a trading tool throughout history. The economy of gold was “the economy” for centuries, and it still wields a significant influence on global trade, investment, and growth.

Since the birth of civilization, people have sought gold as the standard symbol for wealth and prosperity. The more gold you had, the wealthier you were as the metal held its value with impressive consistency. Not much has changed over the last 4000 years—gold is still a status symbol.

As the most precious of the precious metals, gold was historically used as currency. Around 500 BC, countries minted gold coins for international trade, and these coins became a standard exchange mechanism. Its use as a currency continued into the 1930s until the worldwide depression separated the idea of gold as a commodity from other forms of money.

Nationally, the final shift came when the United States transformed the relationship between money and gold reserves in 1971. The dollar would no longer tie to gold for its measure of value. Instead, the United States opened a floating international exchange rate, which is still in place.

High Gold Prices Indicate Problems In the Economy

business man struggling because of stock chart

Gold no longer functions as a direct currency but as a tradable commodity. It has not lost its luster, however. It is as much sought-after by savvy investors as it always was, but does gold still affect the economy?

The first observation by economists is that gold does not necessarily affect the economy as much as it reflects the health of an economy. Gold prices rise with an apparent correlation to economic trouble because:

  • Gold prices reflect sentiment. The price of gold is typically a direct reflection of what professional commodity traders believe about the economy. When they believe that the economy is ailing, investors rush to buy gold, and demand pushes up its price.
  • Gold prices often rise with instability. War, unrest, pandemics, and other factors drive investors to gold. They forgo riskier investment instruments like stocks and bonds and put their money into a ‘safe’ haven of gold.

Investor sentiment could easily indicate a more direct causal link for gold on the economy. For example, if investors begin to see a rise in the price of gold for any reason, they might take it to mean that economic trouble is brewing and run for gold. That would push the price of gold up even faster as prices increase, even when the economy turns out to be fine.

However, while investors pull out of those stocks and bonds, the latent effect is that the prices on those stocks or bonds fall. For the companies who tie their worth to those stocks, a fall in their net value could be detrimental, even when there are no actual political or technological forces justifying the move to gold. Jittery investors directly affect the economy because they drop other investments for the stability of gold.

Good examples of this phenomenon include:

  • During BREXIT (Britain announcing its exit from the European Union) in 2016, gold climbed by $100 an ounce in six hours.
  • When Richard Nixon repelled the “Gold Standard” in 1971, gold’s value doubled in a single day.
  • On September 2, 2011, gold valuation skyrocketed to a new all-time high of almost $1900 an ounce amidst the Eurozone crisis and a weak U.S. jobs report.
  • As COVID-19 worries spread in 2020, gold gained value in leaps and bounds, cresting at an all-time high of over $2000 an ounce on August 7, 2020.

History repeats this correlation with many incidences that show how the price of gold rises when the value of a currency is threatened.

FOREX Markets and Gold

Foreign Exchange (FOREX) markets are popular, with the exchange rate being one of the most important variables for measuring a national economy’s health. The FOREX market is highly volatile, though. As a currency topples in these markets, there is typically a corresponding demand for gold.

For example, when the American dollar reports a slight loss compared to other major currencies like the British pound, gold prices soar abroad. Investors in other countries trade the U.S. dollar (USD), and when it loses value, gold is a wiser investment. When the gold price climbs, many other investors turn to gold and away from the ailing currency, which serves to devalue the currency even further until the balance shifts into a new equilibrium or an event reassures investors that it is safe to return to their FOREX trading posts.

Interest Rates and Gold

When interest rates are low, gold is a far more attractive investment. Fixed-income investments pay out very little at lowered interest rates, and when the rates rise (as they always do), fixed-income instruments often lose value. Gold does not see the same price fluctuations from banking rates, making it a much safer investment when national interest rates are at historic lows.

Why Do People Rush to Buy Gold When Inflation is Looming?

person thinking of buying gold in inflation

Supply and demand control the price of gold (and other commodities). Gold is a precious metal, which also makes it a scarce resource with low volatility and potentially high returns. As the demand goes up (more people investing in gold), the price of gold increases, and the market valuation of paper instruments falls.

Gold is also tangible. If the markets crash, the gold is still in its original form, size, and weight. When the world is uncertain, gold is secure as a universal commodity that is easy to store, trade, or sell for cash.

When the economy seems under threat, many investors turn to gold because:

  • Gold handles risk well. Gold comes with less risk than paper instruments like stocks. If the company you invest in goes under, you lose everything. With gold, its value is intact.
  • Gold holds value. When markets fall and currency fails, gold continues to hold its value as a tradeable asset.
  • Gold provides peace of mind. You should not underestimate the psychological benefit of investing in gold. Uncertain times promote the desire to invest in something tangible. A visual asset you can touch to represent your wealth brings some measure of comfort.

Supply and Demand

If a currency should lose all its value, investors believe that gold would likely be the new currency once again. While there are many ways that gold can affect the economy, the bottom line is that gold is a precious metal. As a scarce and limited resource, it only becomes more valuable as the mining supplies dwindle.

When the supply of gold on earth reaches the end, the precious metal will only increase its worth in the markets. Luckily for gold investors, the demand for gold will always exceed its supply. It will continue to represent excellent investment opportunities on an upswing because:

  • Gold is safe. It is a safer investment than most other choices. Historically, this commodity has continued to appreciate, and it will likely continue to do so.
  • Gold is liquid. It is easy to turn this asset into cash when you need it. Selling gold is simple, including the administrative side of the transaction.
  • Gold is independent. Paper investments like stocks depend heavily on the manager, company, bank, or government holding that stock’s value. Gold stands completely independent of any other person or institution.
  • Gold offers flexibility. Investing in gold does not require a massive outlay of upfront cash like real estate or other investments. You can invest or sell it off in increments if you wish.

Investing in gold is a haven, a proverbial parking lot for wealth if the economy seems too volatile. Gold can offset the decline in stock markets, and it is a reliable hedge against a falling market or inflationary pressures. As demand increases, the gold supply dwindles, and costs climb, so now is the best time to buy if you want to make a move into gold investing.

Is Gold Investing Detrimental to the National or Global Economy?

While it is true when gold prices rise, this is typically an indicator of an unhealthy economy or event that investors are anticipating. However, it is also true that competition drives an economy, and growth depends on many variables, including interest rates. As countries move to adjust these factors and foster conditions for economic growth, investors respond, and gold prices adjust as well.

Investors find gold a safer alternative than a stock market on the downswing, and gold investing can initially drive those numbers south. However, history has shown that the market will typically self-correct when the right factors are in place. If it doesn’t, at least you will be holding a valuable pot of gold that won’t devalue alongside the national currency you would have been counting on to recover.

Investors that choose to diversify their portfolio with gold are making an excellent investment decision. Gold is risk-free and easy to manage, no matter how economic growth is looking overall. Let Oxford Gold Group help you stimulate your personal economy through gold investing to safeguard generational wealth—contact us today.

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