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FED TIGHTENING AND FX INTERVENTIONS REIN IN GOLD RALLY

FED TIGHTENING AND FX INTERVENTIONS REIN IN GOLD RALLY

 A series of geopolitical events coupled with rising U.S. inflation increased gold prices more than fivefold in the later 1970s as financial markets sought refuge in the security of the precious metal from the eroding value of paper money. The falling dollar was exacerbated by OPEC’s price hikes, which added fuel to the inflation fire. Surging social unrest in 1978 led to the 1979 hostage crisis at the U.S. Embassy in Tehran, which culminated in the over-throwing of the Shah and the Iranian Revolution. Oil prices nearly tripled between 1979 and 1980, and gold’s last major surge spiked before start-ing a 20-year period of hibernation. The Soviet invasion and occupation of Afghanistan in December 1979 raised fears of renewed tensions between the United States and the Soviet Union, further destabilizing the security outlook in the region. In just three weeks, gold jumped from $520 to $835 per ounce. But what later ensued was a testament to the importance of economics over geopolitics in the behavior of gold.

In autumn 1979, U.S. inflation hit a 32-year high of 13 percent, despite double-digit interest rates. In October the Federal Reserve, under the new leadership of Paul Volcker, made the historical decision to shift monetary policy toward the targeting of money supply, away from the targeting in-terest rates. This meant that the Fed would manage monetary policy so as to lower monetary aggregates, with interest rates acting as a secondary element. The two years of ultratight monetarism saw interest rates hit 20 percent in 1981, leaving international investors little choice but to seek the high-yielding greenback as a way to offset double-digit inflation. Figure 1.2

FED TIGHTENING AND FX INTERVENTIONS REIN IN GOLD RALLY

FIGURE 1.2 Deteriorating geopolitics of the 1970s propelled gold prices up on the back of soaring inflation before Fed’s tight monetarism headed off 20-year bear market in gold.

Source: U.S. Geological Survey.

shows U.S. inflation was more than halved in 1982, dragging gold down with it. In the first half of the 1980s, the dollar index jumped 50 percent while gold tumbled by the same amount to hit a six-year low.

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