Back in 2006, just two years before the financial crash, a handful of investors and academics warned that the US housing market was in a bubble. They argued that the Federal Reserve had kept interest rates so low for so long that house prices were unsustainably high. People were getting mortgages that were many times their income because interest on the debt was near zero.
Because people could afford more expensive houses, the price of houses continued to rise. Soon everybody wanted a piece of the returns and companies and investors bought millions of dollars of real estate. If you asked people why they were buying real estate, they’d just reply, “it’s a money making machine.” And in a way they were right; real estate prices had risen for decades, and the rise seemed inexorable.
This then generated a bubble economy, where prices soared way above what people could pay if interest rates were normal. As prices continued to rise, the pressure for the bubble to pop increased.
What would happen when the interest rate went up? some people asked. After all, if people had hundreds of thousands of dollars of debt, then even a small rise implied a large increase in mortgage repayments.
In 2008, we got the answer. The bubble finally popped in the late summer of that year. Mortgage lenders stopped receiving payments from the so-called “sub-prime” market. People simply couldn’t afford to pay higher rates of interest on their mortgages. Suddenly the price of houses collapsed, and so too did the value of all the banks’ investments. As the panic spread, banks shut down lending and closed their doors to savers.
Banks quickly hiked up the interbank lending rate because they were scared that other banks had lost money because of the housing crash too. This stopped banks from doing business and caused the credit market to seize up entirely.
We all know what happened next. The world went into meltdown. Central banks around the world feared another Great Depression. They began pumping trillions of dollars into the world’s financial system to head off a full-blown credit crunch. As a result, most banks survived and the world carried on pretty much as normal. But at what cost?
In the past, the Federal Reserve would not have been able to create trillions of dollars of money and pump it into the banking system. Why? Because every note that they issued had to be redeemable in gold. It was a way of making sure the government behaved. It couldn’t just print money because it always had to keep a reserve of gold in storage, just in case. In other words, it made sure that the currency was trustworthy.
But now there is no limit on the power of central banks, like the Federal Reserve. They can type whatever numbers they want into their accounts and create money from thin air. Sounds good right, printing money into your own account? Well not so fast.
After the 2008 financial crisis, people began to wonder whether the currency in their pockets was really going to remain valuable. After all, the central banks had pumped trillions of new dollars into the economy, diluting the value of the dollars in their pockets. The question was, what can I buy whose value isn’t going to be eaten away by inflation?
Many investors turned to gold. Because gold is a currency in its own right, and because the amount of gold in circulation stays about the same, it would retain its value. It’s price in terms of dollars would go up, but that was only because the value of paper money was going down. In other words, investors could use it as a hedge against inflation.
In the months following the financial crash, the price of gold soared. It outperformed practically any other asset for several years.
Eventually, the price peaked in the fall of 2011. But the price of gold did not continue to rise as some had predicted. Why?
Well, you could argue that all that inflation found a new target. Before 2008, low-interest rates meant that house prices inflated. Now, low-interest rates are causing the prices of stocks and shares to rise way above their historical averages. Because people can’t make money just keeping it in the bank anymore, almost everyone is dumping their money into the stock market to make a return. This increases the demand for shares and has led to their prices going up. Prices of stocks and shares no longer reflects the underlying profitability of companies.
As a result, the price of gold fell. The fear of inflation has passed for many people. But this might be an illusion. After all, the world economy is starting to look a lot like it did back in 2008 before the last financial crash. The banks are loaded up with debt, stock prices are out of line with reality and interest rates are still near zero.
If there is another crash, which seems almost certain, it seems imperative to build up a store of gold. When all other assets denominated in terms of paper currency lose their value, gold will not. There are many different types of gold coin you can buy. I won’t discuss them here but you can discover more at Atkinsons Bullion.
Rather than being some relic from the past, it seems that gold bullion can help protect us from an uncertain future. Governments used up all their reserves to fend off the last big recession. This time they don’t have any reserves left. They’re way more indebted than they were in 2008, and their ability to borrow is diminished.
The temptation for governments around the world will be to use their central banks to print money to pay for the debt. They’ll call this fancy names, like “quantitative easing” but it’s essentially the same thing. And as the value of the currency is eroded, people with stocks and cash will suffer. That’s why people are returning to gold in their droves.