Economic Sense: The Secret Reason Behind Gold’s 2014 Rise

March 5, 2014 Updated: April 24, 2016

Spot gold jumped over 2 percent Monday in Comex futures trading. A big up day and a breakout above the important mark of $1,350. Yes, sure, Ukraine had something to do with it. But the real reason behind gold’s 2014 rally is another. 

Over time, the gold price correlates with the total amount of Federal debt and other debt metrics in society. And since the Treasury got the license to issue debt again Feb. 12 with the clean debt-ceiling bill, gold has been off to the races, rising 5 percent. 

Savvy market participants already started bidding up the price at the turn of the year in anticipation. Gold is up 10 percent since Jan. 1, outperforming most other asset classes.

How about the national debt? It actually went down by $92 billion at the beginning of the year until the Senate passed the debt-ceiling bill. In the three short weeks since then, it’s up $168 billion. What’s more, because the debt ceiling is suspended, the Treasury has until March 2015 to issue as much debt as it likes. 

Why does this drive the gold price? Because in today’s society debt is money, even more so than the Federal Reserve Notes printed by the Fed. More money means higher asset prices and that includes gold.

The Treasury can print money (debt) much faster than the Fed; the recent $168 billion in three weeks puts even the $85 billion per month of initial quantitative easing to shame.

Also, new debt issued by the Treasury directly increases the total supply of credit money, whereas QE only increases reserves banks hold at the Fed unless the Fed directly monetizes new issuance. 

Should banks choose to use these reserves, they could increase total credit money supply, but private lending never took off during the recovery. 

Yes, Federal debt rose by 5.5 percent in 2013, a rather slow pace compared to the last decade, when Federal debt nearly tripled. It is also slow compared to the 18 percent annualized pace since Feb. 12. 

Sure, there are periods when the correlation breaks down, like in 2008 or in 2013, but it has worked rather well since the beginning of 2000, the start of the great expansion of Federal debt. 

There is another reason why gold reacts to the issuance of new Federal debt. The gold price is a reflection of faith in the dollar. If the dollar goes down, gold goes up. 

The dollar is ultimately backed by the Fed’s balance sheet. The Fed’s balance sheet is made up mostly of Treasury securities. 

If there is a continuing supply of new securities but no new tax money to pay back the debt, these securities will fall in value. Hence, the balance sheet of the Fed becomes worth less and so will the dollar.