Political Business Cycle

The idea of a political business cycle is one of the theories of the business cycle, formulated in the 1970s. According to it, political incumbents try to juice up the economy during election years to improve their chances of re-election. They stimulate the economy just before an election to increase their odds of remaining in office, while reversing the course and restricting the fiscal and monetary stimuli shortly after the elections (to avoid harmful long-term consequences). Thus, major elections produce economic booms and busts, as politicians try to create an artificial boom before every election and take advantage of the voters' short-sightedness. Similarly, theory and history suggest that the U.S. central bank tries to avoid, if possible, any major monetary actions as an election approaches.

Political Business Cycle and Gold

The knowledge of how politicians influence the economy can help inform investment decisions. The political pattern described above affects the financial markets – some evidence (see the chart below) suggests that equities generally prosper in the second half of a president’s term, while they often have a relatively weak first half. It makes some sense as, in the beginning of their term, a president usually takes a more restrictive stance, whereas towards the end of the presidency fiscal stimulation is more generous.

Chart 1: Average annual return of S&P Index in presidential election years in the post-war period.

Therefore, if the negative correlation between the stock market and gold is true, the shiny metal should perform relatively well during the first half of the term and relatively weakly during the second half of the presidency. However, a careful examination of gold’s performance in the presidential election cycle clearly falsifies the implications of the political business cycle. Although it is true that equities perform relatively weak in the first half of a president’s term and much better during the second half, the price of gold does not reflect this behavior. Actually, the first half is worse for the yellow metal.

We encourage you to learn more about the gold market – not only about its relationship with the political business cycle, but also how to successfully use gold as an investment and how to profitably trade gold. 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.