How Monetary Policy Influences Gold Prices

Of all the precious metals, perhaps none is more sought after than gold. Gold has been used to back up national currencies as early as the Byzantine Empire in 330 A.D. It’s also been the world’s reserve currency for much of the 20th century.

If you’re considering investing in this precious metal, you may be curious about how monetary policy influences gold prices. We’ll explain everything you need to know below.

Introduction to Monetary Policy

Monetary policy is a set of tools a country’s central bank (such as the U.S. Federal Reserve) uses to boost economic growth and control the nation’s overall money supply. To do this, central banks use strategies like buying and selling bonds, targeting foreign exchange rates, and changing the interest rates they charge to loan money to the country’s banks.

Monetary policies may be either expansionary or contractionary, depending on the level of stagnation or growth in the economy. Banks will use expansionary techniques to encourage growth in the middle of a recession or economic slowdown. One strategy is to lower interest rates to promote borrowing and consumer spending.

Banks may use contractionary policies to slow growth and limit inflation when the economy is booming. The prices of goods and services increase, reducing consumers’ purchasing power.

The Role of Gold in the Economy

five two hundred grams gold bars on us banknotes

Even though no country uses the gold standard, this precious metal still plays a major economic role. A nation that has access to gold reserves or exports gold will enjoy a boost in the value of its currency when the price of gold goes up. This is because gold increases the value of its exports, which the country can use to offset a trade deficit or create a trade surplus.

On the other hand, countries that import more gold than they export will experience a drop in the value of their currency when gold prices rise.

When central banks print money to buy gold, they create an excess supply of fiat currency (the type of currency that replaced the gold standard). This alters the supply and demand of that country’s currency, which could cause inflation.

Relationship Between Interest Rates and Gold Prices

Gold prices and interest rates typically have a negative correlation. In other words, when interest rates rise, the price of gold tends to fall, and vice-versa.

When interest rates are low, investors like to put their money into gold to protect their wealth. This happens because low-interest rates devalue the currency, which affects employment, wage growth, and the overall cost of living.

When interest rates rise, other types of investments, such as stocks and bonds, become more appealing. That’s because gold doesn’t provide an annual yield like other investments.

Impact of Inflation and Deflation on Gold Prices

To understand the impact of inflation and deflation on gold prices, we must first explain what these terms mean.

Inflation measures how fast the prices of goods and services are increasing. When goods and services are in high demand, prices rise, which creates scarcity.

Conversely, deflation happens when there’s either insufficient money to buy goods and services or more goods than people are willing to buy.

In times of high inflation, gold prices usually go up. This is because investors see gold as a safe haven that can protect their wealth from rising interest rates.

It’s less well-known how gold performs during times of deflation because such periods are fairly rare. Many analysts think the price of gold should go up during deflation as concerns about debt levels and currency supplies rise.

Central Bank Policies and Gold Prices

hand holding jigsaw puzzle with percentage symbol

Central bank policies, including the raising and lowering of interest rates, are strongly linked to gold prices. There’s a widespread belief that a negative correlation exists between the price of gold and interest rates. Many market watchers believe the price of gold goes up when interest rates rise and falls when they drop.

To illustrate, Russia’s invasion of Ukraine caused global instability, leading to booming gold prices. The Federal Reserve increased interest rates to lower inflation, causing gold prices to tumble.

However, this correlation doesn’t always hold. For instance, in the 1970s, gold reached its all-time high price of the 20th century when interest rates were high and steadily rising. By 1981, the price of gold had gone from $50 per ounce to a whopping $850 per ounce.

In short, there is no single factor driving gold prices. This is why savvy investors pay attention to a constellation of factors, such as geopolitical events.

Geopolitical Factors That Affect Gold Prices

Geopolitical factors are events that can influence various countries’ social, political, and economic policies. They may include, but aren’t limited to:

  • Civil wars
  • Military conflicts
  • Terrorist attacks
  • Sanctions
  • Trade barriers
  • Epidemics and pandemics

Typically, gold prices have a positive correlation with rising tensions. For example, after the 9/11 terrorist attacks in 2001, the price of gold on the London market rose from $271.50 to $287 (an increase of nearly 6%).

Prices don’t always jump in accordance with geopolitical events, though, and even when they do, they may not stay high for long. For instance, after the 2015 attacks in Paris, gold prices spiked briefly, then quickly fell.

Secure Your Retirement With Oxford Gold Group

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Now that you’ve learned how monetary policy influences gold prices, you might wonder whether it’s worth investing in. We understand that figuring out how to get started with precious metals can be confusing.

At Oxford Gold Group, our financial experts will teach you everything you need to know about funding your retirement account with precious metals.

To get started, schedule a call or reach out to us at (833) 600-GOLD today.

Frequently Asked Questions

What currency is affected by gold?

Gold prices largely impact three major currencies: the U.S. dollar (USD), the Australian dollar (AUD), and the Swiss franc (CHF).

What happens when a currency is backed by gold?

When a currency is backed by gold, it’s called the gold standard. That means the currency’s value is directly linked to the value of gold. For example, if the price of gold in the U.S. is $400 per ounce, the dollar’s value would be 1/400th of one ounce of gold.

No country’s government uses the gold standard anymore. It’s been replaced with fiat currency or money that must be accepted according to a government order.

How does gold affect the stock market?

Gold prices and the stock market have a negative correlation. That means when gold prices go up, prices in the stock market tend to fall, and vice versa. Gold bars, gold coins, and gold EFTs all do well when the stock market performs badly.

How would the global currency be affected if gold became abundant?

What might happen to global currencies if gold became abundant is pure speculation. Given how monetary policy influences gold prices, people would probably hoard gold. That could lead to deflation, less money in circulation, and rising unemployment.

It might seem luxurious to imagine a world of gold changing hands on a regular basis. However, if gold were still used as money today, as it was back in the days of the gold standard, an overabundance of it would lead to massive inflation.

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