How Does the Price of Gold Affect The Economy?

  1. Overview

    Introduction

    • There is very little, if any, effect on the economy from the price of gold. If anything, the opposite is usually true: perceptions about the economy can directly affect the price of gold. The usefulness of gold as an economic indicator is questioned by some, but it is still widely recognized as a hedge against the U.S. dollar and as some measure of inflation. Gold is used in most electronic devices such as computers and cell phones, but in such small quantities that fluctuations in the price of gold have very little impact on this sector of the economy.

    Gold and Inflation

    • Traditionally, the price of gold was seen to reflect monetary inflation, that is, inflation of the money supply. Because the fractional reserves banking system under the Federal Reserve is inherently inflationary, the total amount of money in circulation tends to expand, at times rather sharply. If monetary inflation exceeds real growth in products and services, then the result will be price inflation, measured by government metrics such as the Consumer Price Index (CPI) and Producer Price Index (PPI). The balance of supply and demand for gold tends to change relatively little from year to year, so for decades, changes in the price were attributed to inflation. Because rising inflation often coincides with a booming economy, a rise in the gold price is sometimes coincident with a strong economy.

    Gold and the Dollar

    • In a sense, the value of the dollar reflects the health of the US economy. However, in a floating currency system where the dollar is only priced relative to other floating currencies, it is increasingly difficult to use currency movements as a measure of the economy. Still, gold is a very popular hedge for large institutions against devaluation in the US dollar. As the value of the dollar goes down relative to other major currencies, the price of gold tends to move higher, though the correlation is not always perfect. The movements in the dollar, however, can be as much attributable to changes in other national economies than in the U.S. itself. When the dollar is seen to be on the rise, investors tend to flee from gold, causing the price to drop rather precipitously, without necessarily signaling a slowing of inflation.

    Gold and Mining

    • The only real direct effect gold has on the economy is in the mining sector, where individual companies may be highly sensitive to any fluctuation. Because gold miners make their profit from selling gold, their profit margins are largely determined by the prevailing market value of the commodity. In past decades, miners hedged their production in the futures market to create some stability and transparency, but that practice largely ended in the first decade of the twenty-first century as the volatility of gold and its rising price made it unprofitable to do so.

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