[Viewpoint] The Significance of Rising Gold Prices

Kim Young-ik, Adjunct Professor at Sogang University Graduate School of Economics

Recently, the price of gold surpassed $1,730 per ounce, marking the highest level since November 2012. There is a high likelihood that gold prices will continue to rise for a considerable period due to the depreciation of the dollar and an increase in global liquidity.

Analyzing data since 1973, when the US dollar index falls by 1%, gold prices rise by 1.2%. Additionally, when global liquidity and consumer prices increase by 1%, gold prices rise by 1.5% and 0.1%, respectively. First, the value of the dollar, which determines the price of gold, is likely to decline in the long term. The value of a country's currency is an indicator that comprehensively reflects its economic power. The share of the United States in the world’s Gross Domestic Product (GDP) peaked at 35% in 1985, then dropped to 32% in 2001 and further to 21% in 2011. Although the US economy grew relatively strongly afterward, increasing its share to 25% last year, the International Monetary Fund (IMF) forecasts it will fall to 23% in 2024. This implies a decline in the value of the dollar.

Even within this year alone, the dollar is likely to gradually weaken. Recently, the IMF projected the US economic growth rate for this year at minus (-) 5.9%, marking the most severe recession since the early 1930s Great Depression. Although policymakers are responding with bold fiscal and monetary policies, their effects are expected to be less significant than during the 2008 financial crisis. This is because US households and businesses are in the process of reducing debt. The US government will likely induce a weaker dollar policy-wise to stimulate demand in the external sector.

Next, to overcome the economic crisis, central banks worldwide are significantly increasing liquidity through quantitative easing and other measures. The US Federal Reserve (Fed) is leading the 'money printing.' Between February 26 and April 8, the Fed’s assets increased by $1.92 trillion, an unprecedented event in Fed history. Since the Fed will purchase not only government bonds but also commercial mortgage-backed securities and some corporate bonds, liquidity will increase even faster. The Bank of Japan, European Central Bank, and People’s Bank of China are also actively implementing monetary policies. In particular, the Japanese government has decided to spend 108 trillion yen, equivalent to 20% of GDP, to overcome the economic crisis, much of which will be financed through monetary expansion by the Bank of Japan. The Bank of Korea is also actively pursuing monetary policy, lowering the base interest rate to 0.75% for the first time ever.

Liquidity is likely to increase more than the world GDP. The ratio of M2 (broad money) to world GDP, compiled by the World Bank Group, rose significantly from 98% in 2007 to 113% in 2012, which led to gold prices doubling from $840 to $1,900 per ounce. Since last month, major central banks have been injecting even more money to overcome the economic crisis caused by the novel coronavirus (COVID-19). This is creating conditions for another rise in gold prices.

The final factor is inflation. Despite the significant increase in money supply by central banks worldwide, inflation rates remain very low. The US money multiplier (= M2 / base money), which was nine times in 2007, has recently dropped to around four times, and Japan’s money multiplier also plunged from 11 times to three times during the same period, indicating that money is not circulating. Additionally, the global economy’s demand shortage and persistent oversupply are factors stabilizing prices. However, as Nobel laureate economist Milton Friedman said, "Inflation is always and everywhere a monetary phenomenon," when the global economy normalizes, the released money will circulate, and prices may rise. Gold is one of the hedges against inflation.

Gold does not provide interest or dividends like bonds or stocks, so it may be considered a 'hen that lays no eggs.' However, it is highly likely to be an investment asset that can yield capital gains for a considerable period going forward.