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Why do they say that gold is a hedge against deflation?
MrEureka
Posts: 23,946 ✭✭✭✭✭
Recently, I've heard a number of talking heads refer to gold as a hedge against both inflation and deflation. Can you explain what they're talking about?
Andy Lustig
Doggedly collecting coins of the Central American Republic.
Visit the Society of US Pattern Collectors at USPatterns.com.
Doggedly collecting coins of the Central American Republic.
Visit the Society of US Pattern Collectors at USPatterns.com.
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In the 1920's you could have bought a nice suit with a $20 Eagle (basically 1oz of gold) or with a US $20 bill.
Today you can still buy a nice suit for 1oz of gold but you can not with a US $20 bill.
<< <i>This is how it's been explained to me...
In the 1920's you could have bought a nice suit with a $20 Eagle (basically 1oz of gold) or with a US $20 bill.
Today you can still buy a nice suit for 1oz of gold but you can not with a US $20 bill. >>
He is talking about the other way, Deflation, in the OP question...
<< <i>
<< <i>This is how it's been explained to me...
In the 1920's you could have bought a nice suit with a $20 Eagle (basically 1oz of gold) or with a US $20 bill.
Today you can still buy a nice suit for 1oz of gold but you can not with a US $20 bill. >>
He is talking about the other way, Deflation, in the OP question... >>
Oh yeah.
The same investment cannot logically hedge against both inflation and deflation at the same time.
You might say that gold, because it's viewed as "money" by some, doesn't fall "much" in a deflation. Maybe. It certainly fell a lot (about 30%) last fall when deflation reared its head. Its more recent price rise, like its price rise over the past few years, was due to inflation, not deflation, fears.
The psychology that causes gold to benefit from inflation doesn't apply when the fear is of deflation. When there is inflation, or the prospect of it, holding dollars makes no sense because their value is falling. So people to turn gold and other hard assets. In case of the deflation, the opposite is true. The dollars in your hand become progressively more valuable over time. So there's no reason to trade them for gold. That's why gold won't perform well in a deflationary enviroment.
Worry is the interest you pay on a debt you may not owe.
the money spent on the banks, the average
person still has no money and over 1/2 million
more people, each month, have no jobs. Thus I
believe that deflation will last for some time
before Inflation kicks in. Gold is is a
storehouse for absolute value, but is not a hedge
against deflation . In the event that paper money
collapses, then gold will play the role of a life preserver.
Some financial experts have called for a inflationary
depression about to unfold. I believe we will see a
deflationary depression first, followed by inflation in 2010
and 2011. It is not really a problem though, since the world is
expected to end on Dec-23-2012. Have a nice day now!
Camelot
In my opinion, gold will stay strong during the present deflationary period as there is so much uncertainty as to where the world economy is going. The rules of investing are changing each time our present administration comes up with another "great" idea on what to do. Professional investors are at a loss as much as the every day retail investor. That is why there is so much money sitting on the sidelines. They want to know what the new rules are going to be before they jump back in (my guess is that some of that money will be heading into PMs at a level we have never seen).
The bottom line is that the ball has been set in motion, the amount of debt being created and debt that needs to be serviced is almost beyond imagination. We will go from deflation, to inflation, and sadly we may end up with hyper-inflation as there will be no one who can or will want to purchase all of our debt.
The dollar will be destroyed and PM holders (physical and mining stocks) will be in the best position to survive and take advantage of a new beginning.
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Sidebar - this talk of deflation is a smoke screen. They are going to create money as much as it takes. Ben Bernake said so.
I knew it would happen.
The same investment cannot logically hedge against both inflation and deflation at the same time.
Since most people confuse rising prices as "inflation" I'll stick to that for now. Well, it worked exactly that way in the 1970's. Prices on commodities went up, stocks and durable goods went down. That was stagflation. Deflating prices on one set of items, inflating prices on gold. Gold was increasing in value while most assets were decreasing. But since inflation technically has to do with the money supply and not prices, let's go back to that. Price increases or decreases are the end results of tight money (deflation) or loose money (inflation). It sometimes takes years for the effects to be felt. In the event of the US, our money inflation from the 80's and 90's was well hidden by trading our dollars overseas for cheap goods and services. It didn't start to be recognizable in everyday consumer goods & services until after 2002.
We've discussed the D and I scenarios at length over the past 4 years on the Gold Thread. I won't rehash all that here. Gold has proven to do both as the past few years has shown. It's history now, not myth as some would suggest. Notice that gold started moving up in 2002 during a recession (with an increasing money supply and declining stock prices). It had already sniffed out future inflation. Gold started moving up in late 2008 because once again, it had already sniffed out inflation 6-12 months down the road. To those that consider the wholesale dumping of all asset classes in 2008 as deflation that was totally wrong (exceptions were the dollar, Yen, and T-bills). Gold has also moved up during times of panics in the past 4 months that some have called deflationary. Gold stocks in the 1930's were stellar performers (the only means of legal gold investing at that time). The dollar was devalued 40% against gold in 1933.
Considering that the money supply shrunk 37% during 1929-1932 and has increased over 100% in the past year, that's like comparing apples to oranges. We have not decreased the money supply but only slowed its rate of increase.....still inflationary in the longer run. It's been increasing at around 10% yoy since 1996. Do not confuse asset destruction (homes, stocks, businesses, commodities) with monetary deflation. They are totally different. No one was screaming "inflation" from 1995-2002 as home and stock prices soared along with college education costs....while the CPI stayed fairly low and constant. This was "good" inflation or so most thought. Actually it was massive asset inflation, the cost of basic consumer goods and services remained cheap as many came from overseas. That only lasts so long. You can't turn around today and call the inverse of that trend "deflationary" just because it suits one's fancy. Look around today and you will find key services as well as food products and other items increasing in price.....during a deflationary period. When food prices fell during the depression it was also true that gold stocks increased in price. How could that have happened? It did. A conundrum occurs here. Either gold rising in price today is due to inflation (few here buy that) or it is rising in price due to it being a deflationary hedge (ie real money = currency). Gold was real money in the 1930's - in fact the only real money. Today our fiat money is considered "money" but is it? Either gold is money today and we're seeing it maintain value during deflation or we're seeing signs of inflation. It's one or the other.
The quoted statement above is true since the money supply is either deflating or inflating. You cannot have both. But gold has shown to protect one's wealth in either scenario as it occurs (the OP's original question). So right now, we have an inflating monetary base with most of the cash sitting in the big banks. That's what gold has sniffed out since the first bailout bill was proposed. Gold sniffed out inflation in 2002-2003 years before it was showing up in everyday conversations (2004-2007). If the CPI and other indicators hadn't been permanently neutered, you'd have more warning of such changes. You have to go back to the later 1950's to find a time when the money supply shrunk yoy and we were technically in a deflationary state (other times since the FED took over were 1921 and 1929-1932). In those 2 early windows, the FED purposely removed the punch bowl. Most every major US panic of the past 200 years can be traced to bankers or financiers removing the punch bowl. Gold gets a bad rap as being the source of the problem when it is related to paper money flows. Obviously, gold was not the source of the current and past 3 recessions. Had the FED not started massively cutting back on the money supply prior to after Oct 1929 and then continued on that path for some time, the GD would not have been so great.
roadrunner
A worthy question that bears consideration.
Something changed around 2000. After the (mild) 2001 recession, Greenspan cut rates to 1% for way too long, and the money supply shot up (money consisting of cash (about 5%) and bank credit (95%)). People were borrowing like crazy; that's the credit part. The money supply increased; the ratio of private debt to GDP increased by 50% in just 8 years - to almost $42 trillion in private debt:
(You'll note that the last time we were so high was at the start of the depression -- in 1930-32, the huge drop in GDP made the ratio of debt to GDP look even worse than it had been in 1929, even though there was very little new borrowing after 1929. We may see this happen again if GDP continues to fall... as reported today, it fell at a 6.2% annualized rate last quarter. Worst since 1982. Ouch.).
Back to the story. Gold has been responding since 2000 to the large increase in the money supply. But gold wasn't the only thing responding -- other asset classes, like real estate, also inflated dramatically. The difference is that real estate was puffed up due to leverage borrowing; gold was not. Gold was responding to real inflation. Not the BS government consumer price index inflation, but the inflation that showed up when people's homes doubled and tripled in value in a few years; when gas prices quadrupled, etc.
So where are we today? What is arguably the biggest credit bubble in history has burst. I don't see us getting inflation out of that anytime soon. The government will need to print a lot more money for that to happen. Gold may still rise on the perception of future inflation; from its momentum as people see that it's done fairly well over the past year; or for other reasons. There could even be an element of speculation involved. But what I don't see is hyperinflation coming anytime soon. That's why I would have to say that gold's moment probably isn't here yet.
<< <i>Recently, I've heard a number of talking heads refer to gold as a hedge against both inflation and deflation. Can you explain what they're talking about? >>
MrEureka: The last time the US had major deflation was between 1929-1934. In that period of time gold held its value at $20.67 per oz. Then in 1933 and 1934 the US raised the price of gold to $34/oz. So it sounded like gold was a great hedge against inflation, rising while the US dollar was rising in value due to deflation. This is what "they" usually refer to as the ultimate hedge against deflation.
But in reality, the price of gold was controlled by the US government in US dollars because it was able to. The US government at that time, had the world's largest surplus, just like China has today.
So in reality, we are not sure in the past 100 years if in fact, gold is a good hedge against both inflation and deflation.
During the 19th century, it has been shown to be a mediocre hedge against deflation but not necessarily a good or great one at all times.
But quite frankly, a mediocre hedge in times of terrible uncertainty certainly beats just about anything else?
<< <i>"...fiat money is considered "money" but is it?"
A worthy question that bears consideration. >>
Are you referring to "money" as the federal reserve notes in my pocket? Because they are actually just debt instruments.
This is an example of gold as hedge against inflation:
Gold For Bread