A couple months ago I saw a quote by one of George Soros's managers that they were selling gold since the threat of a depression had diminished. This confused me since gold is always mentioned as a hedge against inflation, not deflation. I've tried researching this aspect of gold without finding much. Finally I stumbled on Adrian Day's book "Investing in Resources" and he has a chapter titled "Gold and Resources in Deflation. In this chapter he cites a 1978 study by Jastram which looked at gold prices in England and the US over the past 400 years. He identified 5 deflationary periods. In each of these deflationary periods, the purchasing power of gold appreciated. Day concludes that in deflation prices go down, meaning money is more valuable, and since gold is "pure" money, it rises in value. However, in each of the 7 identified periods of inflation, the purchasing power of gold declined.
So is gold an inflation or deflation hedge?
To me I think gold does best as a hedge against govt/fiscal/market instability. I base this on a simple thought experiment: In either of the extremes of depression or hyperinflation (the ultimate instabilities), what asset would you rather have. Gold would seem to be the asset of choice in either case.
Gold is a hedge against deflation?
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Gold is a hedge against deflation?
Last edited by FarmerD on Thu Aug 18, 2011 10:17 am, edited 1 time in total.
Re: Gold is a hedge against deflation?
I think you are correct: gold is an instability hedge. It's probably not accurate to say that gold is solely an inflation hedge, or solely a deflation hedge, or even both. Instability is the key.
That is a subtlety about gold that really didn't sink in for me until the past couple of years. Seeing the price of gold continue its steady long-term climb in the face of the massive deflationary credit contraction in 2008, and now seeing its price really spike over the past few months--despite the absence of noticeable increases in consumer prices or interest rates--I have been forced to broaden my previously narrow conception of gold as an inflation hedge.
I'm not familiar with the Jastram study you mentioned, but since it was published in 1978--only seven years after the U.S. abandoned the international gold exchange standard--the vast majority of the 400-year period it examined must have taken place prior to the post-1971 monetary system for which Harry Browne specifically designed the PP. The various ways in which gold happened to behave prior to 1971 are likely not terribly relevant to the PP going forward in this 100% fiat money world.
That is a subtlety about gold that really didn't sink in for me until the past couple of years. Seeing the price of gold continue its steady long-term climb in the face of the massive deflationary credit contraction in 2008, and now seeing its price really spike over the past few months--despite the absence of noticeable increases in consumer prices or interest rates--I have been forced to broaden my previously narrow conception of gold as an inflation hedge.
I'm not familiar with the Jastram study you mentioned, but since it was published in 1978--only seven years after the U.S. abandoned the international gold exchange standard--the vast majority of the 400-year period it examined must have taken place prior to the post-1971 monetary system for which Harry Browne specifically designed the PP. The various ways in which gold happened to behave prior to 1971 are likely not terribly relevant to the PP going forward in this 100% fiat money world.
Last edited by Tortoise on Fri Aug 19, 2011 5:06 am, edited 1 time in total.
Re: Gold is a hedge against deflation?
If you think of deflation as meaning that "money" is becoming more valuable over time with respect to productive assets (such as factories, farmland, patents etc etc), goods and services; then it makes perfect sense for gold to be increasing in value. Gold is very much money rather than a productive asset, a good or a service. Central banks try and avoid a deflationary spiral by devaluing currency faster than the "real economy" deflation. Gold gets the double boost of its exchange rate improving against devaluing fiat currencies whilst at the same time "money" in general becomes more valuable with respect to productive assets etc.
"Good judgment comes from experience. Experience comes from bad judgment." - Mulla Nasrudin
Re: Gold is a hedge against deflation?
I think another question to ponder in a fiat world run by people like Bernanke is what are the long term effects of the policy reponses to deflation going to be?
I think that eventual devaluation by whatever means necessary is where you eventually arrive, though it might take many years to get there.
Even during the gold standard era, FDR showed that devaluation was the preferred response to deflation through his repricing of gold.
I think that eventual devaluation by whatever means necessary is where you eventually arrive, though it might take many years to get there.
Even during the gold standard era, FDR showed that devaluation was the preferred response to deflation through his repricing of gold.
Q: “Do you have funny shaped balloons?”
A: “Not unless round is funny.”
A: “Not unless round is funny.”
Re: Gold is a hedge against deflation?
In a deflationary spiral, everyone wants currency.
Gold and dollars are both currency, and so it makes sense that you would be happy with either. However, gold does not pay any interest, therefore although it's a currency, with no threat of inflation I would rather hold dollars because they pay interest.
I tend to think of gold as a currency with a physically limited debasement rate (annual production/ total gold mined) where as dollars have no limit to their debasement rate.
I think this framework can help explain why gold did okay during our last meltdown.
Gold and dollars are both currency, and so it makes sense that you would be happy with either. However, gold does not pay any interest, therefore although it's a currency, with no threat of inflation I would rather hold dollars because they pay interest.
I tend to think of gold as a currency with a physically limited debasement rate (annual production/ total gold mined) where as dollars have no limit to their debasement rate.
I think this framework can help explain why gold did okay during our last meltdown.
everything comes from somewhere and everything goes somewhere
Re: Gold is a hedge against deflation?
melveyr,
The dollar may pay interest, but it's pathetically low if you don't want to take risk... and that pathetic rate is possibly below the rate of "poor man's inflation" (food/fuel) if those costs are going up for non-monetary reasons.
That's why gold might actually do well, not just bobble, in a deflation... I think it needs to be stressed though, that it's the recessionary nature of the depression and what we have today, not prices dropping (directly), that are making gold do well... at least in my opinion.
But all this hilights why gold is really the only commodity you want as a diversifier in your portfolio... the others simply don't react in the way you want them to.
The dollar may pay interest, but it's pathetically low if you don't want to take risk... and that pathetic rate is possibly below the rate of "poor man's inflation" (food/fuel) if those costs are going up for non-monetary reasons.
That's why gold might actually do well, not just bobble, in a deflation... I think it needs to be stressed though, that it's the recessionary nature of the depression and what we have today, not prices dropping (directly), that are making gold do well... at least in my opinion.
But all this hilights why gold is really the only commodity you want as a diversifier in your portfolio... the others simply don't react in the way you want them to.
"Men did not make the earth. It is the value of the improvements only, and not the earth itself, that is individual property. Every proprietor owes to the community a ground rent for the land which he holds."
- Thomas Paine
- Thomas Paine
Re: Gold is a hedge against deflation?
melveyr: when you say gold pays no interest, why do you care about anything other than the real (inflation adjusted) rate of interest? If GBP or USD pay interest less than inflation, then they are worse than gold.
"Good judgment comes from experience. Experience comes from bad judgment." - Mulla Nasrudin
Re: Gold is a hedge against deflation?
Because we are talking about deflation. In a deflationary context the last thing I am worried about is inflation. Here is how I understand the two currencies...
Gold: Relatively fixed debasement rate, but pays no interest
Dollars: Potentially unlimited debasement rate, but pays interest
When prices for good are falling, I would rather be in the currency that is paying interest. However, bottom line is that both are good in a deflation, but dollars have the slight advantage.
EDIT: I am referring to dollars as Treasury securities.
Gold: Relatively fixed debasement rate, but pays no interest
Dollars: Potentially unlimited debasement rate, but pays interest
When prices for good are falling, I would rather be in the currency that is paying interest. However, bottom line is that both are good in a deflation, but dollars have the slight advantage.
EDIT: I am referring to dollars as Treasury securities.
Last edited by melveyr on Fri Aug 19, 2011 11:43 am, edited 1 time in total.
everything comes from somewhere and everything goes somewhere
Re: Gold is a hedge against deflation?
I see what you're saying, Melveyr.
Part of the subtlety in this discussion of how gold should perform in inflationary and deflationary environments is that there seems not to be a clear consensus--even among professional economists--on how inflation and deflation should even be defined. Austrian economists define them in terms of money supply measures, whereas many non-Austrian economists define them in terms of the overall "price level," regardless of what's happening to the underlying money supply.
Given this general disagreement regarding what inflation and deflation really are, it doesn't surprise me at all that the behavior of gold in inflationary and deflationary environments seems strange and inconsistent to some economists and investors.
Moda brought up a good point about "poor man's inflation." Certainly U.S. investors are not currently earning a real return on their dollars since prices of food and other basic consumer goods are rising at a rate higher than the pitifully low rate of interest on short-term Treasuries. This is probably what is attracting a lot of the new longer-term investment in gold.
Perhaps it's most accurate to say that the price of gold reflects both (1) a long-term component and (2) a short-term component. My best guess would be that the long-term bull market in gold began back in 2002 because that was the first time in recent history when short-term Treasury yields first began to dip below the rate of CPI inflation (around 3% at that time) and have remained below it most of the time ever since. People don't want to put their low-risk savings in money that is depreciating in real terms, so they have started putting an increasing amount of it in non-depreciating money--gold. The short-term component of gold's price movements, by contrast, is probably dominated by political instability and its psychological effects on investors.
Ignoring any short-term spikes and crashes in gold's price based on psychology, I'm thinking it's safe to say the long-term component of gold's bull market will not reverse until short-term Treasury yields once again rise above--and stay above--the rate of change in the CPI. That's when people will once again start to view short-term Treasuries as a non-depreciating savings vehicle.
Part of the subtlety in this discussion of how gold should perform in inflationary and deflationary environments is that there seems not to be a clear consensus--even among professional economists--on how inflation and deflation should even be defined. Austrian economists define them in terms of money supply measures, whereas many non-Austrian economists define them in terms of the overall "price level," regardless of what's happening to the underlying money supply.
Given this general disagreement regarding what inflation and deflation really are, it doesn't surprise me at all that the behavior of gold in inflationary and deflationary environments seems strange and inconsistent to some economists and investors.
Moda brought up a good point about "poor man's inflation." Certainly U.S. investors are not currently earning a real return on their dollars since prices of food and other basic consumer goods are rising at a rate higher than the pitifully low rate of interest on short-term Treasuries. This is probably what is attracting a lot of the new longer-term investment in gold.
Perhaps it's most accurate to say that the price of gold reflects both (1) a long-term component and (2) a short-term component. My best guess would be that the long-term bull market in gold began back in 2002 because that was the first time in recent history when short-term Treasury yields first began to dip below the rate of CPI inflation (around 3% at that time) and have remained below it most of the time ever since. People don't want to put their low-risk savings in money that is depreciating in real terms, so they have started putting an increasing amount of it in non-depreciating money--gold. The short-term component of gold's price movements, by contrast, is probably dominated by political instability and its psychological effects on investors.
Ignoring any short-term spikes and crashes in gold's price based on psychology, I'm thinking it's safe to say the long-term component of gold's bull market will not reverse until short-term Treasury yields once again rise above--and stay above--the rate of change in the CPI. That's when people will once again start to view short-term Treasuries as a non-depreciating savings vehicle.
Last edited by Tortoise on Fri Aug 19, 2011 8:39 pm, edited 1 time in total.
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pitbullshark
Re: Gold is a hedge against deflation?
In Harry Browne and Terry Coxon's book, Inflation-Proofing Your Investments (1981), here is what they wrote about gold:
The term "inflation hedge" is a common but misleading description for gold. Gold is a hedge against chaos of any kind [emphasis added], including the chaos and uncertainty that comes from a rising or unpredictable inflation rate.
To the extent that inflation influences the gold price, the prospects for a gold investment are:
Fair if inflation levels off at a somewhat constant rate;
Excellent if inflation continues its gradual rise;
Excellent if there is runaway inflation;
Poor if there's a soft landing; and
Good in the early, most dramatic stages of a deflation, but very poor in the later stages.
Bear in mind that the market for gold is worldwide, and the price is affected by inflation rates in other countries--as well as by political, social, and military conditions, and by economic events unrelated to inflation.
CHAOS, wow, yes, if that doesn't describe the times we are in now, uncertainty as to what the FED will do in any given month, increasing unemployment, fear of shortages and civil unrest, threats of economic collapse, no wonder gold is doing what it is doing right now! (Happy that we all have some!)
The term "inflation hedge" is a common but misleading description for gold. Gold is a hedge against chaos of any kind [emphasis added], including the chaos and uncertainty that comes from a rising or unpredictable inflation rate.
To the extent that inflation influences the gold price, the prospects for a gold investment are:
Fair if inflation levels off at a somewhat constant rate;
Excellent if inflation continues its gradual rise;
Excellent if there is runaway inflation;
Poor if there's a soft landing; and
Good in the early, most dramatic stages of a deflation, but very poor in the later stages.
Bear in mind that the market for gold is worldwide, and the price is affected by inflation rates in other countries--as well as by political, social, and military conditions, and by economic events unrelated to inflation.
CHAOS, wow, yes, if that doesn't describe the times we are in now, uncertainty as to what the FED will do in any given month, increasing unemployment, fear of shortages and civil unrest, threats of economic collapse, no wonder gold is doing what it is doing right now! (Happy that we all have some!)