Gold and Rates Cuts: Another Step Towards QE4

How Monetary Policy is Delaying the Crisis and the Reaction of Gold

Interest rates act like gravity on the economy and monetary policy became one of the most important driver of the economy since 2008.

Following march 2019, the FED made an important change in monetary policy, and progressively became less restrictive, keeping interest rates unchanged.

However, until now they always stressed how they “carefully look at the situation of the economy” to decide what to do with interest rates.

This time instead, when speaking about the economy the FED talked about uncertainty and also anticipated that they would “act as appropriate to sustain the expansion”.

This might be the sign of another pivot in the FED monetary policy, a message that tests the waters and prepares the markets for the possibility of a rate cut in July 2019.

The likelihood of an easing in monetary policy is rising also as a consequence of the rising rate cut sentiment among Fed bankers.

In fact, Powell mentioned that “Overall, our policy discussion focused on the appropriate response to the uncertain environment”.

While stocks reacted positively in the short-term, because accomodative monetary policy continues, one of the most noteworthy reactions can be observed in gold price.

Gold

Soon after the information from the FED hit the market, the gold price took off, recording a new high for the year.

It went to trading above $1,380 as a consequence of the increasing likelihood of a rate cut in July 2019. 

gold-price-june19
Source: BullionVault


Why is that?

Gold is a particular kind of asset that is fixed in supply and has the characteristic of having intrinsic value in itself.

This is the reaction of something that HAS VALUE to the devaluation of something that doesn’t have any real value: the US dollar.

This rapid movement happened just upon the rumors of the FED being even more accommodative. Now, think about the following scenarios:

  • Just imagine how much higher gold would be if the FED decided to cut rates this month.
  • Imagine how much higher gold would be if the FED decides to cut rates next month, in July 2019.
  • Imagine how much higher gold price would be when finally markets realize that the FED is going back to 0 interest rates and perhaps QE4.

This has a strong historical precedent. Take a look at this chart and realize what happened last time that there was zero interest rates and quantitative easing.

gold-price
Gold Fixing Price, 2000–2019. Source: FRED

This is the result of a 100% FIAT currency monetary system.

With the dollar that is not backed by anything real and fixed in supply, like it was the case of gold until the 70s, it is possible to create an unlimited amount of currency to stimulate the economy.

This situation puts the economy in the hands of central banks.

The point is that it works only in the short-term and sooner or later the price must be paid.

Nobody wants a recession, of course politicians and central banks do whatever they can to avoid a recession.

The result of this behavior are bigger and bigger imbalances that every time lead to bigger crisis.

Will there be the ultimate crisis that compensates for all the exuberance of these years?

Nobody knows. But I tell you one thing that hasn’t changed for the last 5000 years and I really don’t see why it should change now, especially when the alternative is a currency with no real value.

As J.P. Morgan once said:

“Money is gold, and nothing else.”

J.P. Morgan

What Does it Mean for the Near Future?

It is clear that monetary policy became one of the main driver of the economy, significantly increasing its importance after the 2008 financial crisis.

Before delivering an official rate cut, the Fed “started to prepare the markets” in advance, changing its language toward an easing in monetary policy.

I totally agree with the FED on the rising uncertainty in the economy.

While markets have short-term gains on the expectation of a rate cut, the real problem is that the U.S. economy is headed into a severe recession that will have negative impact on corporate earnings.

To understand the bigger picture, it is important to realize that

The potential July 2019 rate cut will be the first step towards zero interest rates and a new wave of quantitative easing

This is huge.

What does it mean for the US economy and the dollar?

In the effort of avoiding a recession right now, the FED is doing everything in their hands to keep the economy going.

The problem is that this economic growth is already entirely based on debt sooner or later the economy can’t accept a higher level of debt.

Given the astonishing level of debt and the rising instability it is likely to see a crisis in the coming years, no matter what central banks will do.

What is different this time, is that the FED is cutting rates before the crisis shows up.

It might temporarily give another push to the economy but it will last for a very short time.

What does it mean for the future?

Interest rates are already low, lowering rates before the crisis implies two things for the years to come:

  • Less tools to fight the next recession
  • A further devaluation of the currency

To conclude, this behavior delays the real problem and makes it harder to fight a recession when finally, a further postponing of the problem won’t be no longer possible. Something that might happen within a couple of years.


This article is for informational purposes only, it should not be considered financial advice. You can read the full disclaimer here.

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