The Connection Between gold price And Sovereign Debt
Sovereign debt is the money a country’s government owes to other governments, businesses, or financial institutions. Governments incur sovereign debt through the issuance of bonds, notes, and other debt instruments, as well as through borrowing funds. Governments borrow money for various purposes, including funding public projects and increasing employment.
How does it work?
The amount of sovereign gold bonds and their interest rates also reflect the demand from foreign investors and the savings habits of a nation’s citizens and businesses. Foreign creditors are usually foreign governments who hold some of a country’s debt. Domestic creditors include state and local governments and citizens who have purchased government bonds. Several private agencies frequently rate the creditworthiness of sovereign borrowers and the securities they issue.
Countries with stable political and economic systems are typically seen as having better credit risks, enabling them to borrow on more favourable terms. Governments must pay interest on the debt they incur, just like everyone else. Therefore, fiscal expansion and the consequent increase in sovereign debt could lead to future growth in the tax burden. Foreign governments may start to doubt a country’s assets if sovereign debt keeps increasing.
As a result, the value of the nation’s currency than other currencies may decrease. But if the governments cannot pay off the debt and interest, they may take even more debt to pay off the previous debt. And if the sovereign debt level goes beyond a specific limit – 100% of GDP, as proposed by Reinhart and Rogoff in their book – This Time Is Different: Eight Centuries of Financial Folly – a sovereign debt crisis is said to occur.
As one can imagine, this debt is difficult to pay off. Hence, the countries look for three ways to deal with such situations – they default, revalue their currency against some other superior form of money, or inflate the currency and GDP versus the total debt. However, often, these measures to control debt led to high inflation.
Investors seek shelter to escape the clutches of inflation and get out from the eye of the storm.
During such times, this shelter comes as haven assets – such as gold. Though gold demand never dies down, it increases when investors are financially troubled and expect even more volatile situations in the future. In such cases, investors look to gold and silver to avoid rampant inflation and prevent the ROI on their investment from tumbling.
Since the gold price is expressed in US dollars, it tends to rise when the dollar value decreases due to inflation, which reduces the currency’s purchasing power. Due to this inverse relationship, gold retains its actual value and can be used as a hedge against other dollar assets by investors. For these reasons, the investors prefer several base metals or commodities, such as oil and gas or agricultural gains.