Recently, the price of gold, the price of U.S. Treasury bonds, and the S&P 500 index—which measures the stock performance of 500 of America’s largest companies—all reached all-time highs.
Typically, stocks increase in value when investors are optimistic and expect future earnings to be higher than they had been anticipating.
However, bond prices typically rise when investors are afraid and rushing to the protection of U.S. Treasury bonds, which the United States can always pay back just by printing more money if it has to. That’s why U.S. Treasury bonds are considered “risk-free” in terms of default by many economists.
Can all three sets of investors be right? And how does this relate to our local economy in Southern California?
The key to unlocking what all these signals is the U.S. Federal Reserve, the nation’s central bank.
The Federal Reserve, or the Fed, directly manipulates interest rates banks charge each other. The Fed does so by making money more or less available. When there is more money available, interest rates go down; when less money is available, interest rates go up.
Through this and other less traditional ways of controlling interest rates, the Fed also indirectly affects investors’ and consumers’ expectations for future inflation.
Imagine an economy with 100 units of currency—dollars—and one apple tree that produces exactly 100 apples. Let’s make all the assumptions we need to make so that each apple costs exactly $1. What would you expect to happen to the price of one apple if the king suddenly and secretly creates another hundred units of currency? Eventually, consumers and investors would figure out what had happened and the price of apples would go to $2 per apple from $1.
Through this silly example, we can illustrate what is actually happening in the U.S. economy. In mid-March, the Fed created $1.8 trillion so that consumers and investors could hoard cash and feel safe. While most of that money ended up in people’s bank accounts, they couldn’t spend it. However, in financial markets, the functional equivalent of a bank account is to own Treasury bonds, so investors globally sold their investments and bought Treasuries—driving up the price.
Yields generally run inversely to prices, so the yield on the 10-year Treasury bond slumped to about 0.6 percent from about 2.5 percent.
At the same time, many workers and parents who had to shelter in place, started spending money on technology and home entertainment. So the price of technology stocks went way up—the market value of Apple briefly rose to make it the first company to exceed $2 trillion. That’s driving up the value of some stocks, including home improvement companies Lowe’s and Home Depot, which are also trading at all-time highs.
That explains why bonds—and also many stocks—are at all-time-high prices. But what can we glean from the price of gold?
Many gold investors may be thinking that the pandemic might cause people to turn to gold as a means of buying and selling goods and services. People have trusted gold as a means of exchange and a way to retain wealth during economic collapse since at least the time of King Solomon some 3,000 years ago.
In the past 50 years, Hong Kong and South Korea both had instances when consumers quickly switched to using gold from using the local currency. In Hong Kong, it happened after a bank failure, while in South Korea it occurred during the Asian Debt Crisis in 1998. Other gold investors might be looking at all the cash that was created in mid-March and all the talk of trillions of dollars of new stimulus; they want to hold fewer dollars and own gold if the value of the dollar goes down.
Some gold investors are likely wanting to own physical gold in case the pandemic gets worse. And still others are likely afraid of future inflation and getting out of dollars and other “fiat” currencies controlled by governments and central banks.
Here in Southern California, we are seeing all this play out through property values. Owning a home is another way to protect against future inflation. So, in addition to people moving to lower-density places from higher-density areas because they can now work from home or because they want to escape the risk of physical contagion, there’s also a case to be made that some people want to own their home before all those new dollars drive up the cost of renting.
We will explore this topic more in coming days.
