Does money printing really affect the price of gold?

28 Feb

Yes. Economic theory would suggest so and the proof appears to back the theory.

The quantity theory of money asserts that changes in the quantity of money cause a proportional change in the price level, expressed as:


Where M is money, V is velocity, P is price level and T is trade. PT combined would therefore  = GDP.

Economists are all fighting over whether QE will ultimately lead to inflation. I believe it will but it is fair to say that a huge number of factors affect the CPI, and it isn’t as simple as it sounds.

So let’s simplify it. Let’s just look at whether QE could lead to gold price inflation. Given both gold and the dollar are units of currency, one can simplify the equation to M = P or 1 unit of USD = 1 unit of Gold. Given that gold can’t be printed, a doubling of ‘M’, for example, should lead to a rise in P. i.e. P = 2M or 1 unit of gold now equals 2 USDs.

Has gold been rising with money supply?

The chart below shows the US Monetary Base overlaid by the price of gold going back to 1960. Given the dollar was taken off the gold standard in 1968, one would expect some deviation between the two series, but the correlation is still very striking.
US monetary base vs Gold
(Source: Bloomberg)

Another interesting chart looks at the size of the Fed’s balance sheet. The white line shows the staggering expansion of the Federal Reserve’s balance sheet which has expanded by US$2.5 trillion since 2007. To put this in context, it took almost 100 years for the Fed to build its balance sheet to US$0.9 trillion and it then almost tripled this in the last four years.

However, if we look at the Fed’s balance sheet in gold terms (orange line) we can see that it hasn’t actually expanded by anywhere near as much. In fact it’s about the same size as it was back in 1997!

Fed Balance sheet price in gold
(Source: Bloomberg)

Unemployment remains high (U6 unemployment remains at 14.4%) and the economy is yet to recover. No, we haven’t even mentioned sequestration yet. The Fed will not be stopping QE any time soon and gold’s upwards trajectory is therefore unlikely to deviate too far from the trail of the US’s highly expansive monetary base.

One Response to “Does money printing really affect the price of gold?”

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