Causes of Great Recession
There were multiple causes of this crisis. First of all, after the dot-com bubble burst, the Fed maintained excessively low interest rates for too long, fueling the housing bubble. Moreover, the government conducted policies intended to promote home ownership, even by people who were not able to afford it. The excessive risk-taking with toxic mortgages and derivatives, and record household debt (partially resulting from too low interest rates) also contributed to the economic imbalances and financial instability.
Effects of Great Recession
The Great Recession led to a rise in unemployment, an increase in bankruptcies and a rise in government debt, especially in Europe where the financial crisis morphed into sovereign debt crises as many countries decided to bail the banks out (the U.S. federal government injected $700 billion to purchase distressed assets). Central banks responded aggressively to the crisis. For example, the Fed quickly started to purchase assets under its quantitative easing programs and slashed interest rates, as one can see in the chart below.
Chart 1: Effective federal funds rate (green line, left axis, in percent) and price of gold (yellow line, right scale, London P.M. fixing) from 1968 to 2015.
Great Recession and Gold
The Great Recession boosted the price of gold, although it declined in the very aftermath of the Lehman Brothers’ bankruptcy, probably due to the forced sales in order to raise cash. However, it quickly rebounded and ended 2008 in positive territory. And in 2009 and 2010 it really shined, outperforming many other assets. The chart below compares the historic behavior of gold and S&P 500 Index – the divergence after the beginning of the crisis is clear.
Chart 2: Price of gold (red line, left axis, London P.M. Fix) and S&P 500 Index (green line, right axis) from 1968 to 2015.
It should not be surprising as gold prices act as an indicator of the health of the economy. In times of crisis and elevated risk aversion, many investors turn to gold, the ultimate safe haven, to protect their capital. When the economy recovered, gold lost its appeal as insurance against the breakdown of the monetary system based on fiat currencies and the gold bull market ended in 2012.
We encourage you to learn more about the gold market – not only about how the Great Recession affected it, but also how to successfully use gold as an investment and how to profitably trade it. A great way to start is to sign up for our gold newsletter today. It’s free and if you don’t like it, you can easily unsubscribe.