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How Has The Federal Reserve Impacted Gold Since 2009?
By Kira Brecht Kitco NewsThursday October 16, 2014 10:25 AM
(Kitco News) - The last five years will be forever marked on the history books with some of the most innovative, aggressive and controversial actions by the U.S. Federal Reserve ever.
There are critics and there are fans of former Federal Reserve Chairman Ben Bernanke, and perhaps the jury is still out on his overall handling of the 2008-2009 global financial crisis. After all, the massive programs that he left in place are just now starting to be unwound. There remain many hurdles and uncharted waters for the central bank to navigate through on its unprecedented unwind and exit of the massive and extraordinary monetary policy initiatives of recent years.
While Fed actions were not the only driver of gold prices during the last five years, many will argue they played a large part. However, another major underlying bullish factor into the 2011 price high was the massive financial crisis which struck the global economy and years later still leaves its impact with sluggish growth. In times of panic, fear and crisis, investors have over the millennium turned to gold as a safe-haven investment and that in part played a role behind the bull run seen into the 2011 price high for gold at above $1,900 per ounce. But, the Fed's policies were extremely significant as well.
Many will remember well the chaos and fear that struck financial markets in mid September 2008. The week of September 15 will be remembered with some of the largest financial upheavals ever seen. That week started with the Fannie Mae and Freddie Mac takeover, the Lehman bankruptcy, the AIG bailout, and ended with the introduction of massive government legislation to buy the toxic mortgage debt. The implosion on Wall Street was historic and the unprecedented moves seen by the authorities in its wake dramatically changed the nature of the U.S. banking, financial and monetary policy system.
While the former Fed chairman Bernanke has had critics, there are others who credit him with saving the U.S. economy from the brink of a second Great Depression. Almost immediately in response to the crisis, the Fed slashed the official federal funds rate to a historic low at zero to 0.25% in December 2008 —and it has remained there since.
In general, low interest rates are bearish for a currency, or in this case the U.S. dollar. When currency traders compare "rate differentials" between currencies, generally those with a higher interest rate are seen as more attractive. Thus, one key way in which Federal Reserve policies impacted gold over the past five years is the massive pressure it kept on the U.S. dollar. Gold, of course, is priced in U.S. dollars and a weaker dollar tends to be bullish for commodities. See Figure 1 below.
Another major way in which Fed policy impacted the rising price of gold from 2009 into 2011-2012 was the massive expansion of the Fed's balance sheet. Amid efforts to stimulate economic growth and keep liquidity moving through the financial system, the Fed drastically increased the size of its balance sheet to unprecedented and record-size levels.
Under Bernanke's leadership the Fed's balance sheet soared from $850 billion prior to the 2008 global financial crisis to about $4.4 trillion, as of early October 2014. The first large scale asset purchase program, knowing popularly as quantitative easing (QE) was established in December 2008 and added to in March 2009. That was followed by QE2 in November 2010 and then in September 2012, the Fed announced open ended purchases of $85 billion per month, known as QE3.
"The major impact the Fed has had is through its monetary policy," said Jeffrey Christian, managing partner at CPM Group. "Going back to 2009, and the first large scale asset purchases, or quantitative easing, you saw that influx of cash as they were buying all these bonds. It caused investors to be concerned about the inflationary implications, and contributed to the rise in the price of gold," he said.
As the Fed instituted the QE programs, "investors were buying gold in expectation of a future inflationary response, which has not occurred. Inflation hasn't come," Christian said. Taking a look at one of the Fed's favored inflation gauges: the PCE Price Index, the latest reading in August revealed a 1.5% reading, below the Fed's target range of about 2.0-2.5%.
Higher levels of inflation than the current 1.5% are seen as desirable from an economic perspective, as it is a spillover of strong and sustainable economic growth. For example, higher pressure on wages, can lead to higher income levels, which in turn puts more money in a consumer's pocket, which in turn can lead to even greater economic growth.
Peter A. Grant, chief market analyst at USA Gold weighed in. "The huge expansion of the monetary base was generally negative for the dollar. And, there were pretty substantial expectations that the Fed's drive to create inflation would be successful. Despite all they did and the $4 trillion plus balance sheet, they were unsuccessful in generating inflation," Grant said.
He pointed to the general price retreat in gold from late 2012 and noted the Fed's failure to stimulate strong enough economic growth to produce inflation "played a significant role in that decline. A lot of that inflation risk got unwound in the market," Grant explained.
Going forward, the Fed's impact on gold is mostly likely not complete, as it relates to the overall economic growth environment. "Since 2009, not only the Fed, but in Europe and Japan has seen a move in which private debt markets have been squeezed," said CPM Group's Christian. "Total debt in the world has been rising over the last five years. But, the private sector—consumers and businesses have been squeezed out of the debt market," he said.
"You've seen total debt rise, but the percentage of total debt represented by monetary authorities has risen. This limits the ability of the private sector to recover," Christian said. After all, "economic growth is fueled by credit provision," he explained.
Pointing to the Fed's actions in recent years, Christian added: "we had to do that medicine in order to avoid a depression and much worse. But, the monetary medicine we took had unfortunate side effects, which are limiting the recovery. We are hoping they can move to a more normal credit market where businesses and individuals can access the credit market and will aid in the economic recovery," Christian concluded.
Bottom line? Over the last five years, the Fed's monetary policies most certainly had a significant impact on gold through both the expectations for and subsequent lack of inflation, and its influence on the U.S. dollar.
While the U.S. economy continues to improve slowly, there remain many hurdles both on the global front and amid the structural debt and deficit issues of not only the United States, but other major industrialized economies. Some point to the theories of secular stagnation and a new normal for advanced industrialized central banks, which could include easy and accommodative monetary policies for perhaps years to come. The impact of global central bank action on gold continues to evolve and will remain a key factor for the yellow metal in the years ahead.
By Kira Brecht, Kitco.com
Follow her on Twitter @KiraBrecht
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