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How gold protects against inflation

26 November 2021

Tuesday 23 November 2021

 
  • What causes inflation?
  • Why does inflation matter?
  • Gold as an inflation hedge
Shae Russell
Shae Russell,
Group Communications Manager

Dear Investor,

Today in our ongoing ‘beginner to bullion’ series, we look at one of the most important reasons to own gold. But first, let’s start with the basics.

What is inflation and how does it impact you?

Inflation is ‘the sustained upward movement in the overall price of goods and services in an economy’. In far more simple terms, it means prices rise over time which in turn increase the cost of living.

Another way of looking at inflation, is that the $50 note in your wallet buys you less and less each year.

When you hear commentators refer to inflation however, they are talking a broad formula which measures price changes. There are many thousands of items across an economy where price changes are captured. Things such as housing costs, cars, food, petrol, clothing, technology, electricity, education and health care are just some of the many categories measured when it comes to calculating inflation.

So, what causes prices to rise?

What causes inflation?

There are several main causes of inflation:

Cost-push inflation: Cost-push inflation occurs when overall prices increase because production costs have gone up. The price rises have happened either because of wages and/or the cost of raw materials have risen. The higher costs of goods and services are generally passed onto consumers. Cost-push inflation means the demand for goods hasn’t changed, rather it’s the inputs their comprised of have increased. Cost-push inflation can happen for a number of reasons. For example, natural disasters such as bush fires can impact agriculture, resulting in food certain shortages.

Demand-pull inflation: Demand-pull inflation happens when a certain product or service is in high demand, but there is a supply shortage. In other words, when demand for something outstrips availability prices rise rather than production increases.

Currency devaluation: People often think of currency devaluation as something that occurs in developing economies, however currency devaluation can have an inflationary impact in advanced economies too. Devaluing a currency makes a country’s exports cheaper to overseas nations while driving up the value of imported products. Higher prices of imported goods encourage people to buy locally made goods instead. Alternatively, currency devaluation can be deliberate because a lower currency benefits the economy. For example, the People’s
Bank of China have periodically intervention and set the price of the Yuan lower to the US dollar. Other types of currency intervention can be when a central bank buys and sells its own currency in the forex market to keep the currency (generally) lower.  

Policies and regulations: Governments can create policies to influence either cost push or demand-pull inflation. Changes in taxes or subsidies are often used by governments to attempt to control or change consumption of certain goods and services.  

Expansion of the money supply: Increasing the money supply means the amount of money in circulation in the economy has grown. So, not just an increase coins and notes in people’s hands, but also an increase in the amount of lending from credit providers. Expansionary policies can be done in two ways. The first one is through fiscal means such as governments reducing taxes and/or increasing government spending. The second option is monetary, where central banks lower interest rates, or reduce the amount of cash a bank must hold (known as reducing the ‘reserve requirement’) or even buy back government securities.

Why does it matter?

Some causes of inflation are normal within an economy. Though sometimes governments and central banks set out to engineer inflation to smooth over economic cycles. The merits of which we’ll have to discuss another time.

The important thing to remember, is that we live in an economy where both the Reserve Bank of Australia (RBA) and Australian government favour creeping inflation. That is where they set policies to encourage slow price rises year on year. The RBA currently have an inflation target band of 2-3%. Meaning they want to see price rises increase between 2-3% each year.

This way inflation is small enough that you don’t notice it every day, but it ‘boosts’ demand as people assume prices will rise and they will buy now to beat the increases. The RBA’s attempts is to achieve steady economic expansion this way.  

Gold as inflation hedge

The problem with this of course, is that even mild inflation erodes your purchasing power. Coupled with lack lustre interest rates, many investors are looking for ways to protect their capital.

Gold has long been used as an inflation hedge as it hold its value over the long term. Often precious metals such as gold will give higher than inflation returns. Too boot, gold doesn’t need extreme inflation to rise. The price of gold can increase slowly over time with creeping inflation. Here’s a great video that explains this.

Australia has seen minimal inflation in the past decade yet the Australian dollar gold price has risen exceptionally well during this period.

Furthermore, with interest rates at all time lows, expansionary monetary policy, global uncertainty and as we emerge from the pandemic into our new normal, investing in physical gold can assist you in reaching your wealth goals.

If you want to use gold as way to protect yourself against inflation click here, or call one of ABC Bullion team members now on 1300 361 261 to get started.

Until next time,
Shae Russell
Group Communications Manager,
For ABC Bullion