Stagflation and Gold Price Action

Posted - September 2, 2022
Stagflation and Gold Price Action

Stagflation is a common problem experienced by economies all over the world. The term itself is a combination of two existing words, inflation and stagnation. Because of this convenient mash-up, it’s not difficult to figure out what stagflation refers to. When an economy experiences stagflation, this means that prices rise while economic production stagnates. The results can be devastating; a stagflationary economy often leads to increased unemployment and higher poverty rates.

The unique economic problem of stagflation was actually not thought possible until the 70s. United States economists long thought that slowed economic growth would typically be associated with steady inflation and unemployment rates. During the 1970s, however, high inflation was actually combined with high unemployment and inhibited economic expansion. 

Since then, stagflation has been one of the biggest fears of economists all over the world. Particularly in the United States, some economic thinkers believe that stagflation is on the horizon – which could be devastating for an economy that has already been hurt by the effects of the COVID-19 pandemic. If the U.S. were to experience stagflation, it could spell a major recession in the years to come. 

Gold has long been considered to be an effective hedge against inflation. Investors frequently stockpile gold in the hopes that the tangible asset will prove valuable as the worth of the dollar continues to fall. In the case of stagflation, the benefits of owning gold may be even more pronounced. While there is no surefire way to protect your assets against the natural (and unnatural) waxes and wanes of the U.S. economy, experts believe that gold and stagflation may go together as part of a well-rounded investment plan. 

This guide will introduce you to a brief history of stagflation in the United States. We’ll also cover some important facts about the relationship between gold and stagflation, as well as a few predictions for how gold price action may be affected by a stagflationary economy. 

What is Stagflation? 

Stagflation may seem complicated, but the issue is actually relatively simple. The term combines two separate economic concepts: inflation and stagnation. Inflation refers to the diminishing purchasing power of currency. The value of the dollar begins to decrease over time, especially if too much currency is printed. As the price of goods rises, this can be disastrous. Hyper-inflation is the extreme version of regular inflation; hyper-inflation may mean that consumers pay millions of dollars for a loaf of bread or a gallon of milk! 

Stagnation characterizes an economy that is slowed for an extended period of time. Under a stagnationary economy, things may not seem so bad. But while wages and prices tend to remain stable, unemployment rates sometimes rise considerably, which can eventually lead to economic recession and additional issues. Much of the economic threat associated with stagnation comes from the market’s reaction. When wages are stagnant for too long, people tend to refrain from making larger purchases, which prolongs the period of stagnation – and can in turn cause worsening economic conditions. 

By themselves, both inflation and stagnation can be regular parts of a healthy economic cycle. When wages stagnate, people might save their money, reducing inflation, and spend regularly when the economy begins to grow again. And when inflation is accompanied by increased wages, consumers might be compelled to make greater purchases and help boost production as a result. 

But the two economic phenomena can sometimes combine to make a perfect storm. When stagflation occurs, unemployment increases while the purchasing power of the dollar decreases. Stagnation and inflation happen at the same time. It isn’t difficult to understand why this could spell disaster for the United States economy. 

Stagflation in the United States: A Brief History

Stagflation is not a new phenomenon, but it is a relatively recent concept in modern economics. In fact, it is frequently asserted that classic economic theories were unable to account for the stagflation that first occurred in the 1970s within the United States. The 1970s stagflation is a particularly popular talking point for consumers and economists worried about the current state of the economy. There are a few reasons for this, but the main parallel is that the 1970s led to one of the most significant inflationary periods in oil/gas prices the country had ever seen. 

There are a number of reasons why the United States may have experienced stagflation during this decade. A greater number of countries experiencing rapid industrialization led to high steel competition, and an oil crisis in 1973 only made things worse for a stagnating U.S. economy. The recession only lasted a couple of years, but its impacts resounded for nearly a decade. 

Economists were perplexed by the stagflationary economy for a couple of reasons. For one, the rate of inflation for consumer goods – particularly steel and gas – were shocking. But more importantly, economic theorists didn’t know how to account for the existence of both inflation and high unemployment at the same time. Since then, economists have made significant strides in their understanding of stagflation, as well as the relationship between economic stagnation and gold price action. 

Stagflation and Gold

As we mentioned above, stagflation was a shockingly good time for gold investments. Gold price action from this period of time shows an eightfold increase in the value of gold during the peak of the 1970s stagflation. Coincidentally, gold was one of the few assets which experienced peak performance during the stagflationary period of the 1970s. While gold was only worth around $100 per ounce at the onset of the stagflation period, it climbed to around $800 per ounce by the end of it! Studying the gold price action during this period might be important for investors who are looking to hedge their bets against a stagflationary economic phase. 

This means that the stagflation period of the U.S. economy provides gold investors with a valuable insight into how the commodity might be used to counteract inflation and economic stagnation. We already know that gold tends to increase in value during times of low consumer confidence in the economy. When people feel that the economy may be heading downhill, they often turn their sights to physical assets like gold, silver, or platinum. 

This certainly appears to have been the case in 1973, when gold hit new highs at the peak of one of the most disastrous periods in recent U.S. economic history. Stagflation and gold have a close relationship among investors during periods of economic decline. Following the 2008 stock market crash, gold increased in price by around 50%. Gold also has done historically well during periods of political or economic turmoil; the outbreak of the Russian invasion of Ukraine, for example, correlated with an increase in the value of physical commodities like precious metals. 

But the United States has not recently experienced stagflation to the extent that we saw in the 1970s. While the invasion of Ukraine led to the greatest increase in market demand for Gold since May of 2021, this does not seem to be the end of political and economic instability in the U.S. – and all over the world. 

One thing is for sure: stagflation and gold price action seem to be positively correlated. While it is difficult to make certain predictions about the future of the market, gold in stagflation might be a solid investment choice for investors who are concerned about the future of U.S. economic growth. 

Gold Versus Stocks in Stagflation Markets

It’s hard to compare gold price action to stock market performance, especially in times of recession. After all, these two types of investments are radically different from one another. However, evidence seems to suggest that physical precious metals and stock values are negatively correlated. When the stock market performs particularly well, the price of gold either stagnates or deflates. But when consumer confidence is low and the stock market stagnates or crashes, demand for gold tends to skyrocket. 

Gold is a physical commodity, and its value is not linked to the performance of a company or consumer confidence in a larger economy. In fact, the opposite might be true. In many cases, low consumer faith in the stock market means that gold presents itself as a valuable commodity. 

One popular interest of gold investors is to counterbalance inflation. The value and purchasing power of the dollar begins to decrease during a period of inflation. This explains rising gas prices and skyrocketing costs of basic commodities like baby formula, milk, and bread. But the purchasing power of gold remains relatively static, because gold is not dependent on circulating amounts and printed quantities of the dollar. 

In other words, it’s not possible for the government to mint too much gold and cause a deflation to its value, while the same cannot be said for the American dollar. 

In a stagflationary economy, attempting to counterbalance the effects of inflation using traditional stocks might be like trying to put out a house fire by turning on the stove. As wages stagnate, unemployment increases, and the value of the dollar decreases, few people will spend their cash on stocks – which is certainly not a good thing for the state of the overall market. 

Gold might not have the same problem. As a physical asset divorced from consumer confidence in the general economy, it tends to increase in value as the value of various stocks and currencies decrease. 

How Does Stagflation Affect Gold Price Action? 

What about thoughts on gold in stagflation? There is limited data on how stagflation affects gold price action, considering that the U.S. has only really seen one major example of true stagflation. But it is possible to use both the stagflationary economy of the 1970s and the recession of the 2000s to paint a picture of how physical precious metals fare during periods of sustained economic decline. 

During both the 1970s stagflation and the 2000s recessions, it seems to be the case that gold price action paints a positive picture. Even in the midst of the COVID-19 pandemic, gold did shockingly well – especially when compared to traditional stock assets. While no investor should consider gold to be the full extent of their investment strategy, there is a long American tradition of using gold to combat inflation and secure monetary stability during unstable times.

Gold in stagflation is considered a wise investment strategy for conservative portfolios, according to at least some economists. While we won’t recommend one choice or another, the evidence does suggest that using gold to counteract the effects of a stagflation economy might be one way for investors to keep ahold of their assets during collapse. 

Final Thoughts: Fighting Stagnation and Gold

Gold has been the predominant precious metal asset for centuries – and with good reason. Gold holds its value, even during times of economic instability. It is impossible to predict the future. While some gold sellers will attempt to scare investors into buying gold coins or bars by claiming that the world economy will soon collapse entirely, we don’t plan on making any of these wild speculations. 

Instead, we offer a basic overview of the relationship between stagflation and gold price action. The outlook is good; stagflationary economic phases tend to mean only positive things for gold, which has been used for decades as a part of a prepared investment plan. Inflation and economic stagnation combine during a stagflationary economy, which spells trouble for both unemployment rates and the value of the dollar. But because gold has a set supply and is not generally influenced by policy decisions to print more fiat dollars, it can serve as an important asset for those investors who worry about the economic future of stagflation that might be on the U.S. horizon. 

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