Central banks could soon turn their taps back on

The Bank of England
The Bank of England

Gold has just hit an all time high of $2,100 an ounce. Bitcoin, touted as a digital version of the precious metal, has soared back above $40,000 a unit, doubling in a year. Even the bond market is rallying.

There is a stark message in those extreme price movements. It is not just that interest rates may have peaked as inflation starts to come under control. The markets are betting that central banks will soon have no choice but start printing money again to bail out bankrupt governments.

The stock market has been drifting aimlessly for the last month, and currency rates have been broadly stable. But the price of gold has now surpassed the all time highs reached in the wake of the 2008 and 2009 financial crisis. Although there are lots of skeptics about the precious metal, it has risen five-fold over the last twenty years – more than can be said for most other assets. Measured in sterling, it has done even better, rising from £234 an ounce two decades ago to more than £1,500 an ounce now.

Likewise, Bitcoin, which enthusiasts like to portray as a digital version of gold, is now back above $40,000 a unit. It has more than doubled over the past year, rising from $16,000 a unit, and it is getting back towards the levels last seen at the height of the Covid pandemic. People keep on writing Bitcoin off as a flimsy get–rich-quick scheme that will soon collapse. Yet it keeps on bouncing back, often stronger than ever.

True, there are some perfectly straightforward explanations for why the price of both assets is going up. The gold price has been static for a long time, and when interest rates are rising, as they have been for the last twelve months, you would expect it to fall in value. Meanwhile, the Chinese Central Bank has been a big buyer throughout this year, perhaps preparing itself for financial sanctions from the US if there is a conflict over Taiwan.

And Bitcoin is always very volatile. After the collapse of FTX, the main crypto exchange, it was bound to take a hit to its price, not least because it was harder to trade. In the background, inflation is starting to fall, and interest rates may soon come down. That has sparked a rally in the markets – globally bonds added $390 billion in value in the last week alone – and that has spilled over into other assets.

And yet, there could be a bigger explanation. Both gold and Bitcoin are a way of positioning a portfolio for one significant development: the world’s major central banks starting to print money again. Gold (for a couple of millennia at least), and Bitcoin are fundamentally a hedge against the debasement of the currency. There is only so much gold in the world, with mining adding marginal amounts each year, so it holds its value when there is lots of paper currency floating around. The same is true for Bitcoin. Indeed, it was specifically designed to be outside the control of central banks, and to offer a more reliable store of value.

Will we see a restart of quantitative easing? There are two reasons to think that we might.

First, central banks have over-done the rise in interest rates, going from close to zero to 5pc or more in the space of a year. The money supply figures, which most central banks seemed to have been ignoring, already suggest we are heading into a deep recession.

Economies in France and Germany are now shrinking while the UK is stagnant, and may well be contracting again soon. The US is still expanding at a rapid clip of course, but that is partly thanks to President Biden’s $700-billion splurge of industrial subsidies. In a recession, central banks will slash interest rates, and may well restart QE as well.

The second, and more important reason, is this. Bankrupt governments don’t have any other alternative. Interest bills have soared for governments that have far more debt than in the past. In the UK, debt interest now takes up 10pc of government spending. It is the largest single item of government spending after the NHS. In the US, the annual interest bill has soared past $1 trillion a year. In France, the finance ministry forecasts that the cost of servicing its debts will rise from 41 billion euros this year to 71 billion euros by 2027.

In the UK, an incoming Labour government plans huge new spending programmes, while a second term Biden administration will double down on its industrial plan. Governments are borrowing cash simply to service the debt on all the money they already owe. It is unsustainable.

The only way governments will be able to keep the show on the road is to start printing money again. Sure, we don’t quite know what the excuse will be. It could be a recession, with the argument that only QE can fight that. It might well be climate change, with “green money” printed to finance the energy transition. Or it might be some version of People’s QE, an old favorite of the Labour Party.

The important point is this. The markets are betting it will happen very soon – and that gold and Bitcoin will be the only real beneficiaries of another wild, self-indulgent round of printed money.

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