Leaving the thrills of the weekend of football behind, yours truly is back amongst the midst of writing the blog for you, my dear readers. The topic could leave a few eyebrows raised and a few shrugging of shoulders as the hike in the gold prices is attributed to the US liquidity trap. Read on!

While browsing through the internet, I stumbled across an interesting article by Paul Krugman, a Nobel laureate in economics. The article offers an explanation for the hike in the gold prices of recent years. Krugman, who believes the US is currently in a liquidity trap, thinks that the gain in gold is another confirmation for a liquidity trap. He retrospect -in a liquidity trap people and businesses ‘sit on their money’ and even if interest rates plunge to zero, investors are still reluctant to invest their funds.

It’s hard to prove that the US are in a liquidity trap because even if the rates are low and the economy is slowing down, there is still no evidence of deflation, especially after the recent CPI report showed the US inflation rate stands at 2.2% in annual terms. But let’s not accept this analysis and explain the recent gains in gold prices.

According to Krugman, people are holding on to resources such as gold and postponing the usage of said resources for the future in times when the interest rates are low. In simple words, since people don’t receive good returns on their investments due to low interest rates and liquidity trap means people are sitting on funds whereas investors have an incentive to hoard gold. It means the expectations of inflation weren’t the cause of the gold prices hike. The problem is the spike in gold came mostly after the Quantitative Easing plans which the Fed had enforced in 2008 and 2010. Furthermore, the recent pledge of the Fed to keep the rates low until late 2014 has reignited hopes of another round of QE program in the future. This pledge had boosted the prices of gold in the last month. Sharp gains in gold prices came during that time when people may have anticipated a jump in the inflation rate and depreciation in the USD against other currencies.

Krugman’s theory also states that if the US is in a liquidity trap, then gold shouldn’t rise as much in the near future as it did in the past couple of years. If you are persuaded by this theory, then the rally in gold is over and we could see only moderate increases in the near future. If the opposite is true, it could result in signs of inflation or an additional expansion of the US Monetary base. Which theory do you behold?

Note: The blog is just an expression of the author’s opinion and cannot be deemed responsible for any losses incurred.