Have You Been Fooled By This Chart? QE vs Gold

April 1, 2021

Have You Been Fooled By This Chart? QE vs Gold

Has central bank QE really caused gold prices to soar?

Here is another famous chart, circulated widely around financial circles ever since the modern Fed first employed QE in 2009.

The chart shows gold prices soaring along with massive increases in bank reserves, the idea being that the Fed’s massive “money printing“ has led to the debasement of the USD relative to gold.

How true is this?

Mainstream narratives say that QE is money printing that causes gold prices to soar This is not true

The debasement narrative runs further, with gold touted as the haven against “inevitable” inflation (some go so far as to suggest hyperinflation), as well as the “ineluctable” destruction of the dollar.

Unfortunately for those who have bought into this narrative, it simply is not true, because QE does not work in the way they think it does.

For the debasement narrative to work, there has to be an increase in money supply in the economy. The narrative rests on the belief that this increase comes about from all the reserves that the Fed has printed to pay for its QE purchases.

As we now know, those reserves are stuck in the banking system. Bank reserves are not lent out, which means the reserves that were printed into existence because of QE do not enter the economy.

As such, money supply in the economy has not skyrocketed in the way people believe it has.

Supporting this is the fact that inflation has failed to materialize in any sustained, meaningful fashion, much less in a manner needed for hyperinflation.

While there has been lots of asset price inflation, this is more a function of credit availability based on a bifurcated labor market than broad based inflation due to an out of control money supply.

Furthermore, money velocity in the States is at abysmally low levels, which makes one wonder: if velocity is at multi-decade lows, and money supply isn’t growing because QE does not work, what kind of broad based inflation is there to be had?

Additionally, the lack of money supply growth in the economy also means that the USD has not been debased into destruction.

This is because, 1) QE is nothing more than an asset swap where no new assets are created, and 2) the reserves that the Fed swaps for USTs (and MBS etc) are stuck on bank balance sheets and cannot be circulated in the economy.

In fact, the lack of USD debasement is clearly demonstrated by the dollar’s upward trend against a broad basket of currencies ever since QE1 in 2009.

Why then does gold keep moving higher with each iteration of QE?

Because of Paradigm. Everyone believes that QE = printing money, and acts accordingly. It doesn’t matter if the narrative is erroneous, it only matters that people believe in it*.

Add into the mix a good dose of FOMO, people mistaking correlation with causation, and the spark of QE is lit on the kindling of misunderstanding.

*There are those who think in the opposite way, that QE is evidence of policymakers’ failure, but still end up buying the precious metal anyway – as a hedge against the government.