Crises are situations in which many people begin to look for tools that allow them to preserve their purchasing power in the long term. For decades, central banks have reacted to recessions by printing money, which erodes the purchasing power of the population.
At the height of the pandemic, unprecedented peacetime currency inflation was reached . The effects of this situation, in particular the dramatic increase in the prices of consumer goods and production goods, began to be felt already at the beginning of 2021. By the end of the year, price increases in many regions recorded the highest rates in recent years decades. Especially in the euro area, growth was the highest ever recorded .
Historically, gold has always represented insurance against loss of purchasing power. Our times are no exception. In this case, we will analyze how gold behaves in crisis situations and compare it with the most common assets in Romania.
Currency (Fiat Money)
Keeping money – either in a bank deposit or in cash – is one of the most common forms of saving. Data from the National Bank of Romania show that household deposits amounted to just over 247.4 billion lei at the end of September 2020, up 15.4% on an annual basis. The amounts of money kept “under the mattress” can be speculated and are probably not small at all. The situation is no different in the rest of the Balkan peninsula.
Saving fiat money in cash has a huge downside – its purchasing power erodes due to inflation (which is an increase in the money supply). The lei savings made in the mid-1990s and earlier are now completely wiped out by hyperinflation. Making a calculation based on World Bank data,it becomes clear that if a Romanian had saved 10,000 lei on January 1, 2001, today he could buy goods and services with a real value of only 1,900 lei.
The dynamics in Serbia and Bulgaria are similar. In reality, inflation is much higher because the consumer price index does not include the prices of all types of goods in the economy. This phenomenon, albeit on a smaller scale, is observed throughout the world.
With inflation chronically eroding purchasing power, fiat money is not a suitable vehicle for long-term savings. The only thing they are guaranteed to bring in the future is impoverishment.
Another favorite form of “saving” in Europe and especially in the Balkan Peninsula is real estate. As a physical asset, they have an undeniable utility. The property can also be used to generate additional rental income. Many people are under the impression that the price of a home never goes down, even in times of crisis. Let’s see if this is really the case.
When interest rates are artificially low, real estate booms disproportionately more than other sectors. In its latest financial stability report, the European Central Bank also warned of explosive inflation in this sector.
Credit-driven booms in the housing market could lead to huge risks to financial stability. Industry booms and busts are associated with deep recessions and financial crises, especially when growth is driven by debt. The housing bubble in the US that preceded the global financial crisis is the most eloquent example of this. During a boom period, rising property prices and credit can lead to a correction in overvalued housing, impacting the economy and financial system through multiple channels.
Any rise in interest rates, as expected, at least nominally, in the US, for example, could be the cause of a new housing bubble. As the infographic shows, in some regions of the world, including the US and Europe, the sector is more inflated today than it was in 2008. Therefore, its collapse will be even more spectacular. As can be seen from the data, real estate prices could remain low for a long period of time as a result of such a bubble.
Crashing prices aren’t the only downside to property. Most mortgages have a variable rate. An increase in interest rates means that the cost of administering them will also increase. Thus, property can quickly become a nightmare “investment” (even if chronic maintenance and depreciation costs are not taken into account) – its value will collapse when the bubble bursts, and the amounts that buyers will have to pay will grow.
So, real estate is an asset that is significantly affected in times of crisis. Data for the US also shows that their price rose before each of the recessions of 1974, 1980, 1990, 2007 and 2020 and always collapsed at the peak. It was only during the dotcom bubble that property values didn’t fall because then dollar inflation was mostly directed to the stock markets.
The volumes traded on the stock exchanges re negligible compared to the size of deposits, as well as to that of regulated markets in developed economies. It can be said that almost no Romanian invests his funds in the stock market.
Since 1990, the stock market in the United States has increased 5 to 7 times. The Dow Jones Industrial Average rose from 5,772 points before the 1990 crisis to 35,927 points in mid-December 2021. The S&P 500 rose from 727 to 4,709 points over the same period. This seems like a pretty good value preservation option.
But, just like the real estate sector, stock markets are also affected by any crisis. Placing money in stocks or indices may seem very tempting when markets are rising, but in frequent crashes, if they do not understand the fundamentals, investors usually sell the assets en masse and experience losses because they are extremely sensitive to the psychological impact. This is especially true if they traded with leverage, i.e. on credit.
So the “bare” numbers don’t say much about why the exchanges are doing well. In the last crisis of 2020, they outperformed gold but lost to silver. The reason is of course the central bank’s injection of a historically record amount of newly printed money into regulated markets.
This means there is only one way for stock markets if central banks stop printing money and raise interest rates: down.