Thursday, December 13, 2018Canada's Leading Online Business Magazine

Is Gold an Economic Accelerator?

By Mark Borkowski

Gold can have multiple personalities. Sometimes it can act like a hedge against inflation. Sometimes it can act like a safe haven asset. But its most important attribute is something that most people don’t even tend to think about. Sometimes it can act like a barometer of economic success. Sometimes the price of gold can be considered an “economic stimulus gage”.

I recently had a chance to interview Mike Verge, author of the newly published book, ‘Global Deflation, and the Next Great American Decade to Come’ and available on Amazon. He says that to really prosper in our changing global economy, you must understand gold. The first part of understanding gold is to realize that it can have multiple personalities and can switch between them at a moment’s notice. The second part is to recognize the personality of the moment and deal with it independently.

In his book Verge argues that the most important attribute of gold is that it is not reproducible. You can’t duplicate it and you can’t print more of it. Although there are a number of gold mines on the world, they add very little incremental gold to the system every year. For all intents and purposes the amount of gold we have now is the same as we will have one hundred years from now.

Unlike printed money, if work is performed in return for one ounce of gold, it will retain its value whether you are paid in one, ten or one hundred years. The good news is that gold tends to retain its value. The bad news is that it doesn’t earn interest. Therefore, most of the time gold can behave like any other asset that does not earn a return. It can behave like land.

In our fascinating interview, he went on to explain how gold can be thought of being like land on the outskirts of a city. At a very general level, the value of land would increase if the city was expanding and people would agree to pay more for that land in the future. Likewise its value would decrease if the city was shrinking and people would pay less. However, interest rates can have a very big impact on the future price of this land.

If the land was expected to go up by 4% per year (inflation) and interest rates were three percent, would you buy it? Yes because you could borrow the money for less than the return. The ‘real interest rate’ to you the buyer would be negative. It would be minus one. If interest rates were 5%, would you buy the same piece of land? No because the real interest rate to you would be positive. It would be plus one. The difference between the return on the asset and the interest rate is called the “real interest rate”. Therefore, most of the time, assets like land and gold go up if the real interest rate is negative (accelerant) and it goes down if real interest rates are positive (brakes). Negative Real Interest Rates are the Real Economic Stimulant!

Using his argument then, one of the biggest factors affecting the price of gold is the U.S. federal reserve. They make an estimate of future inflation and then decide on an interest rate policy. If their interest rate plan is lower than the forecasted inflation rate, gold and many other assets will increase in value. This is considered an accommodative or simulative policy. This action could also be considered an accelerant. If their interest rate plan is to be higher than inflation, then asset prices will decline. This could be considered the economic equivalent of putting on the brakes.

With this analogy, therefore, the price of gold can be considered a proxy for the amount of stimulation in the system. A low price of gold indicates low stimulation, while a high price for gold indicates high stimulation.
Is gold over $1,000 per ounce an economic accelerator? As you can see from Verge’s model above, the price of gold goes up when investors think that interest rates will go below the rate of inflation and real interest rates will go negative. This can happen in times of inflation or deflation. The further negative the real rates go, the higher the price of gold.

From general observations, it could be reasonable to assume that the neutral rate for gold could be around $1,000 USD. That means that if the real interest rate were zero, (no accelerant or brakes) the price of gold would be $1,000 USD. If real interest rates go up (brakes), gold would go below $1,000. If real interest rates go negative (accelerant) then gold would go over $1,000. So although gold does not really accelerate the economy, it can be a reliable indicator of how much stimulant or “accelerant” is being applied to the market.

A scenario including extreme global deflation could require a lot of stimulation or “accelerant” from governments or central banks. This could be in the form of real interest rates in the range of negative two or three or even four percent. At minus three or four percent, gold could skyrocket to three or even four thousand dollars per ounce. At these prices, gold would certainly be a very visible and obvious indicator.

In his book Global Deflation, he develops a number of new intuitive models. His model for gold is just one of them. He calls his new models “Economic Sunglasses”. They must be working because when I read his book and put on his sunglasses everything becomes much more clear and understandable. It is actually quite fascinating. So he goes on to say that, with respect to gold, although it is not an actual accelerator, it can be viewed as a proxy for stimulus or accelerant. It can be a very simple accelerator gage on the dashboard of our global economic engine. So, with Verge’s new concept, what would I do if I were Janet Yellen entering a severely deflationary period? I would go with extreme negative real interest rates, turn on the accelerant, and ramp up the price of gold. I would, in effect, put the pedal to the metal.

Mark Borkowski is president of Mercantile Mergers & Acquisitions Corp. Mercantile is a mid-market business brokerage focused on selling companies to strategic buyers, private equity firms and high net worth individuals.