Gold Performance During Inflation and Deflation

Many observers acknowledge that gold is a good hedge against inflation, as currencies are debased by central bankers. What they don't understand is that gold performs even better with deflation, which accompanies monetary disorder. They don't realize that gold is a safe haven asset when confidence in other asset classes dissipate, as they eventually do with government over-indebtedness and reckless currency and credit creation.

In other words, in a time of crisis, gold isn't just a commodity. It's a sound currency which will maintain its value, unlike fiat currency backed by nothing tangible.

Look at the chart of equities (S&P 500) vs. gold. Since 2001, the global economy has experienced two deflationary (or at least disinflationary) wipe outs. Inflation has been dormant--at least according to official CPI statistics (which is another boondoggle). Gold should have underperformed in that type of environment, according to conventional wisdom. Yet, during this time period of deflation, stocks have doubled, while gold has surged 3 1/2 fold. So the answer to the question: "when should one hold gold: to hedge against inflation or deflation?", is simple. It's both.

Recent Economic Data Shows the Good Side of Deflation

http://mises.org/library/recent-economic-data-shows-good-side-deflation

Death Of Free Markets As Deflation Engulfs The World

http://kingworldnews.com/death-free-markets-deflation-engulfs-world/

Deflation comes knocking at the door

http://www.goldmoney.com/research/analysis/deflation-comes-knocking-at-the-door

Why We're Poorer: Inflation and Deflation Are Now Globalized

http://charleshughsmith.blogspot.com/2014/10/why-were-poorer-inflation-and-deflation.html

Everything We Are Told About Deflation Is A Lie

http://www.zerohedge.com/news/2014-04-19/everything-we-are-told-about-deflation-lie

The Most Important Video You Will Watch Today

http://youtu.be/dUIGKTYwxd8

Historic Chaos, Crisis & The War Between Inflation & Deflation

http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2013/11/20_Historic_Chaos%2C_Crisis_%26_The_War_Between_Inflation_%26_Deflation.html

Why Deflation Is Good for Precious Metals

http://seekingalpha.com/article/183323-why-deflation-is-good-for-precious-metals

Deflation: Making Sure "It" Doesn't Happen Here - Ben Bernanke

Anticipating Fed monetary policies are key to formulating investment theses.  The link below is a peak into Fed Chairman Ben Bernanke's thoughts on fighting deflation before he became Chairman.  It serves as a road map for policies the Fed has since deployed to counteract the financial crisis, including Quantitative Easing (purchase of Treasury bonds and mortgage-backed securities) and Operation Twist (selling short-term Treasuries and buying long-term Treasury bonds).  See the excerpt below on FDR's dollar devaluation when he confiscated gold in 1933 (emphasis in boldface is mine).

For those with time constraints, the key take away is the Fed's monetary policies are inherently inflationary, and explicitly devalue the USDollar.  In other words, as long as these policies are in place, gold--priced in dollars, can only go up.

Contrast that to new Treasury Secretary nominee Jack Lew's declaration that the US Treasury will maintain its "strong dollar policy."  Whatever.

http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm

The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning. A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject's oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior). Normally, money is injected into the economy through asset purchases by the Federal Reserve. To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys. Alternatively, the Fed could find other ways of injecting money into the system--for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities. Each method of adding money to the economy has advantages and drawbacks, both technical and economic. One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies. Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.

So what then might the Fed do if its target interest rate, the overnight federal funds rate, fell to zero? One relatively straightforward extension of current procedures would be to try to stimulate spending by lowering rates further out along the Treasury term structure--that is, rates on government bonds of longer maturities. There are at least two ways of bringing down longer-term rates, which are complementary and could be employed separately or in combination. One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period. Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time--if it were credible--would induce a decline in longer-term rates. A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields. If this program were successful, not only would yields on medium-term Treasury securities fall, but (because of links operating through expectations of future interest rates) yields on longer-term public and private debt (such as mortgages) would likely fall as well.

The Fed can inject money into the economy in still other ways. For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt. Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt. 

Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934. The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.

Fiscal Policy
Each of the policy options I have discussed so far involves the Fed's acting on its own. In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money. 

 Of course, in lieu of tax cuts or increases in transfers the government could increase spending on current goods and services or even acquire existing real or financial assets. If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.

If You Want to Help the Poor and the Middle Class, Encourage Deflation

http://www.oftwominds.com/blogsept12/deflation-is-good9-12.html

Artemis On Volatility At World's End: Deflation, Hyperinflation And The Alchemy Of Risk

http://www.zerohedge.com/news/artemis-volatility-worlds-end-deflation-hyperinflation-and-alchemy-risk

Will Higher Interest Rates Derail Gold?

I've always posited gold performs well during inflation--but even better during deflation.  And while negative real (inflation-adjusted) interest rates are bullish for gold, so are rising nominal interest rates.  The key component of a bull market in precious metals is a loss of confidence in the paper currency. 

http://expectedreturnsblog.com/will-higher-interest-rates-derail-gold/

Inflation, Deflation, and Stagflation, Japan and the US

http://jessescrossroadscafe.blogspot.com/2011/06/inflation-deflation-and-stagflation.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+JessesCafeAmericain+%28Jesse%27s+Caf%C3%A9+Am%C3%A9ricain%29

WHY CREDIT DEFLATION IS MORE LIKELY THAN MASS INFLATION: AN AUSTRIAN OVERVIEW OF THE INFLATION VERSUS DEFLATION DEBATE

Here is a compelling case for credit deflation instead of hyperinflation--by a Libertarian Austrian economist.

http://libertarianpapers.org/articles/2010/lp-2-43.pdf

Gold: inflation and deflation.

The Euro crashes due to intensified fears of a Greek default, and rising Spanish bond yields.  The USDollar rises as a result.  Which means gold should plummet, right?  Wrong, gold surged in a flight to safety today.

Many investors correctly buy gold as an inflation hedge.  What they don't realize is that gold performs even better in a deflationary environment, as debt default risk rises.  When the credibility of sovereign debt and paper currencies erode, precious metals remain a safe haven.

Here’s Why Hyperinflationist Lira Is Wrong

Rick Ackerman is losing his argument that we have deflation.  In the interest of fairness, and since every dog has his day, I am posting his latest opinion on the inflation vs. deflation debate. 

http://www.rickackerman.com/2011/04/heres-why-hyperinflationist-lira-is-wrong/#more-33355

Hoenig Says Lower And Middle Classes Pay "Dear Price" For Fed Mistakes, Accuses Fed Of Commodity Price Inflation

Good timing on Fed governor Hoenig's part:  he speaks the truth as he is about to retire.


http://www.zerohedge.com/article/hoenig-says-lower-and-middle-classes-pay-dear-price-fed-mistakes-accuses-fed-commodity-price

"While some of the increase may reflect global supply and demand conditions, at least some of the increase is driven by highly accommodative monetary policies in the United States and other economies."

For those terrified by the ravages of deflation: "I tracked the average growth of money and the price levels in the United States from the 19th century to the present (Chart 3). It should surprise no one that there is a striking parallel between the long-run growth of money and the growth in the price-level index. From the end of World War II alone, the price index has increased by a factor of ten. With such a track record, it is hard to accept that deflation should be the world’s dominant concern."


"Central bankers must look to the long run. If current policy remains in place, we almost certainly will stimulate the growth of asset values and inflation. This may temporarily increase GDP and employment, but in the long run, we risk instability, damaging inflation and lost jobs, which is a dear price for middle and lower income citizens to pay."

Save your nickels

At current price levels, their melt value is $0.06. If inflation gets worse, nickel and copper prices will rise further, and the melt value will rise accordingly. If deflation sets in, the nickel still has a face value of $0.05.

http://www.coinflation.com/coins/1946-2007-Jefferson-Nickel-Value.html

The mechanisms of a currency war (21st century trade war)

Now that we know WHY countries want to debase their currencies, let's explore HOW they are doing it. If a sovereign central bank wants to devalue the local currency, they simply buy USDollars. Buying USDollars has the net effect of selling the local currency, driving down the value of that local currency. The intervention mechanisms are becoming more complex, as central banks are using derivatives in the foreign currency markets. But all things being equal, they buy the USDollar and short their local currency. The Fed and US Treasury are more than willing to print more USDollars to accommodate Congress, the Administration, and US government and consumer spending. The global financial system is built on a glut of USDollars--and the debt resulting from the creation of said dollars. Of course, this puts a higher burden on US taxpayers.

The world is awash with USDollars--that is the lighter fluid. Money velocity--the so-called multiplier effect of money exchanging hands, is the match. Once lit, prices rise as multiple dollars chase a finite supply of goods and services. This causes price inflation, something the Fed believes is under their control, as they attempt to fight a spiraling deflationary environment. The problem is that inflation can turn into hyperinflation overnight. A controlled fire can morph into an out of control, ranging combustion.

A depression is terrible, but hyperinflation is much worse, as it causes a complete loss of confidence in the currency.