The main utilised tool of monetary policy was control of the money supply. Primarily this was done by adjusting interest rates, otherwise known as the cost of borrowing. In times of economic downturn rates would be set lower to encourage borrowing, in turn stimulating spending and investment. This would also be set to prevent deflation and get inflation back on target.
In times of economic expansion, rates would be increased in an attempt to stop the economy from overheating, to prevent reckless borrowing and thus encourage saving and to get inflation lower.
However, in the past two decades, especially the last , central banks have come up with a myriad of new tools, policies and programmes designed to primarily ensure inflation remains positive but also help debt-fuelled economies maintain solvency and liquidity. The pace and scale of these programmes have been exceptionally controversial, and their efficacy questioned.
This lesson aims to familiarise you with some of the alphabet soup of acronyms that appear more and more in the media and that have a significant influence on the gold price. The below are all still considered “unconventional monetary policy” and all meant to be stimulative for economies. They are designed to make investors take more risk, for businesses to invest and for consumers to borrow and spend more.
QE & APPs
Quantitative Easing (QE) is a form of a central bank-led Asset Purchase Programme (APP). QE first came to real prominence in during the 2008/2009 financial crisis as a means to get the economy started again in the United States. Since then, many other central banks have embarked on their own programmes of QE.
QE is a policy where the central bank buys government (usually) bonds in the market. The large-scale purchases of governments has a number of consequences. First of all, the bonds are taken out of the market and replaced with cash, which can then be used to purchase riskier assets. Second, by buying bonds the central bank pushes the price of the bonds up, making them less attractive to investors. This is because as bond prices go up the yield (or interest) goes down meaning investors get a smaller return than previously. Additionally, this lower interest rate helps governments, corporates and even individuals refinance their existing debt and more attractive, cheaper rates.
As the cash from QE flows into the market and into riskier assets such as stocks and real estate, their price rises. This is intended to create a wealth effect where everyone who owns the assets feels wealthier and it is then hoped that in turn spending and investing rise.
The European Central Bank for example has bought almost EUR3 Trillion of assets, and not just government bonds, in the last few years to stimulate the economy. So far, the jury is out as to how effective this has been. However, the policy does not look like changing any time soon.
Negative interest rates are another controversial measure which some countries’ central banks have used. The idea behind negative rates is to discourage saving which is deemed not useful for economic growth. Instead by charging banks and in some cases citizens interest on their deposits it is intended that the cash is moved out of the account and into riskier assets such as real estate or stocks, or is spent within the economy.
Again, the full consequences of negative rates are not yet fully understood. In the Eurozone banks’ profits have been hit hard as their margins on their loan businesses have decreased. On a more philosophical view, some question the idea of punishing savers who have prudently saved their money for a rainy day or house deposit and forcing them into assets that are not in line with their own financial objectives.
Yield Curve Control
YCC or yield curve control is the policy potentially next in line to be implemented in the West. Used by the United States in WWII and by Japan from late 2016 YCC it aims to peg or cap the long-term borrowing rate of a nation at a certain level in order help reduce debt costs. Whenever the yield of the long-term bond rises above a certain level the central bank buys a sufficient quantity to drive the price up thus decreasing the yield back under the desired target. For savers and big investors in government bonds such as pensions funds, this poses big problems. Like other forms of forced decreases in interest rates, it could also encourage reckless borrowing further increasing future insolvencies, defaults or even a financial crisis.
The Effect on Gold
Whatever policy is used to increase the money supply or force savers away from cash gold is usually a beneficiary. This is because gold is seen as the ultimate store of wealth and is considered a safe haven asset. New and aggressive policies do little to give people faith in the economy. History is littered with similar actions by governments or empires trying to devalue their currencies by increasing the money supply. Some view this as the “debasement” of the currency.
With so many countries now involved in these policies, there is the sense that this really is a race to the bottom. Japan, as the leader in the field, has struggled to create a return to normal economic growth or to create inflation. Yet, the policy consensus remains committed to these policies. As the value of cash continues to go down relatively, holding it is penalised, gold stands to continue to benefit.