Gold Price to Keep Rising as Deflation Hits, US Dollar Loses Value


A Dear Reader asks:

“I am a New Zealand subscriber to The Daily Reckoning and a reader of Empire of Debt.
“I realise many of the arguments for inflation as being good for gold. Where I have trouble is making a case for gold rising during deflation. The fact that gold rose in value in the 1930’s I believe is not relevant. The U.S.A. is off the gold standard and cannot arbitrarily change the price of gold.
“So, how does deflation increase peoples’ desire to hold gold?”

The case for gold is obvious when consumer prices are rising. Gold tends to rise along with them…and then races ahead, as people turn to gold to protect themselves from inflation.

How about when prices are falling? Isn’t it better to hold onto to cash – even paper currency – rather than gold? Well, yes…and no. Falling prices mean that the currency itself is becoming more valuable. As long as that is happening, gold is not needed for protection – at least, not against falling currency.

But when prices fall, typically, they do not fall alone. Instead, they come plunging down along with businesses, junk bonds, hedge funds, stocks, careers, property values, retirement plans and credits of all sorts. People become worried about the quality…that is, the real value…of their assets. They look for something solid to hold onto…a way to protect their assets from markdowns, defaults and bankruptcies. Gold, the only credit that is not also someone else’s debit, is a good way to avoid depression-style losses. You don’t have to worry about someone making his monthly payments, or a business paying its quarterly dividend or making good on its bond coupons. Gold pays no dividends or interest. But investment returns go negative in a deflationary slump; as we pointed out yesterday, the ‘cost’ of holding gold goes down…and then turns, relatively, positive.

Another thing that happens when economies face deflation is that monetary authorities tend to panic. Pretty soon…up is down…down is up. A genuine consumer price deflation in America or Britain would be so painful our central banks, and our political leaders, couldn’t stand it. Consumers have too much debt. How they’d howl!

This summer, equity prices fell less than 10%. Still, within days, it sent central banks scrambling to get more credit into the system. Imagine what would happen if stocks went down 20%…or 50%! Ben Bernanke said he would drop paper money out of helicopters, if that were what it took to avoid consumer price deflation. We don’t have to tell you want would happen to the value of the currency. Even before the helicopters took off, it would be in freefall…with gold rising on the other side.

Bill Bonner
The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

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  1. Two questions, tho:

    1) When prices fall along with everything else – as you point out – people rush to sell whatever solid assets they have so they can meet their obligations. Why would they not sell off gold as well? Thus driving the price DOWN…and making gold a losing investment during deflation? Good time to BUY it then, maybe…after the sell-off…?

    2) Again, as you say, monetary authorities would panic – the central banks would sell their gold in an effort to keep prices down, I would think. Again, doesn’t this mean that in deflation we’re better advised to convert as much as we can to cash? (Including our gold…?)

    That’s of course assuming we can find a currency that seems stable.

    I’m really asking. I love the bright yellow metal and hold it dear myself. But I am not sure how I’d feel about keeping it if I were a strapped debtor….

  2. Gold owners hopefully would not be carrying any obligations at this stage of the credit cycle, so they won’t need to sell their gold. During a deflation, gold increasingly comes to be viewed as money and can be seen as an alternative source of liquidity. The ‘price’ of gold could still fall, but not nearly as fast as the prices of other assets. Remember wages will also be falling, so gold will become increasingly important to the saver, and therefore increasingly sought after. Central banks know all of the above and will be keen to keep what little gold remains to them, as no-one will want their bond offerings. Remember also that the majority of gold is held in private (hopefully strong) hands. Many of these private owners reside in India where I understand export restrictions exist for gold. ie. it goes in, but doesn’t come out again.

  3. Correction: India no longer has export restrictions

  4. In a deflation scenario,
    1. I wouldn’t put my cash in the bank, because I am afraid the bank would go bankrupt. It simply means the bank borrows money from me and then says “sorry I can’t repay you”. Physical gold wouldn’t have this problem, unless you lend it to somebody for interest.
    2. I probably will buy government bond or get cash stored in my bank deposit box. But most likely the central bank will keep printing money via social welfare system or government spending. I don’t object people to own physical bond or physical cash. But before the deflation comes, it’s usually inflation. Would you hold physical cash or bond in inflation? Can you time the market to sell everything before the crash? This is the risk I don’t want to take.
    3. Foreign Curreny? Maybe. If it’s global deflation, probably not good either. And you also need to take into account the possibility of exchange control. And where do you store your foreign currency? Bank?
    4. Gold. Unless a person holding gold is heavily leveraged. And he has to sell off his gold to cover his mortgage, margin call. I believe there would be an initial sell-off in gold, but eventually it would come back up or at least wouldn’t decrease in value as much as other assets, because the amount of gold ever mined is limited and it’s no one’s liability.
    Paper money is all about people’s confidence. But I am afraid that people’s confidence is very fragile. Nowadays, every household behaves like a hedge fund. It doesn’t matter what happen in the world, an ounce of gold will be still worth something in the foreseeable future, but paper currencies could literally go to zero value.
    Most importantly, in the case of the deflation, do not own debt. Preserving savings is more important than earning money in deflation. It’s not about the value of gold going up in absolute terms, it is about one ounce of gold can buy more things in relative terms, in other words, gold’s purchasing power is increased.

  5. “home building, a most mercurial industry, had been falling for several years, and it slumped still farther in 1929.”

    The Great Crash,1929, chapter v, by J.K. Galbraith

    my dad was a runner on wall street when the crash occurred. he spoke of this thing that came out of nowhere; people jumping out of windows, banks offering to pay part of your deposit if you agreed to fore go the balance, how he lost a good friend who borrowed some money and never paid it back, sweetening his coffee with a lollipop because sugar was expensive,etc.
    he was a smart kid so he survived.
    before he passed on he left me some advice(gold).

  6. Just stumbled across this and a year after the last post, things certainly have changed. And gold IS going down just as predicted because entities are selling it to make ends meet. The government HAS panicked a with the trillion dollar credit bail. We appear to be heading into a strong deflationary period, with oil now following home prices and stocks downward big time. So we are about to find out what will happen AFTER the massive sell off to meet obligations, wanes. If it is a worldwide deflation its a complete toss up as to where gold will end up against each currency. A dollar that is strong only because it is less of a depression here than elsewhere is not REALLY a good thing, now is it.

  7. Isn’t anyone’s guess. I can see the validity in maintaining property that has worth to the individual. Gold always will have worth. It may not be as to convert into cash readily as other items but it least doesn’t have the downside of bonds, bank accounts, stocks and CD’s it is not imaginary and based on others obligations and purported worth. Gold is not debt painted over.

    Keith Guyman
    February 3, 2009

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