Inflation/Deflation And Gold

From time to time I will participate in the conversation on various blogs when I see someone who I know has some intelligence write something about gold’s price history that might influence people not to invest in the precious metal, when there are a multitude of reasons to invest in gold.

One of the typical objections that people will throw out for gold is the inflationary years of the 70′s and 80′s and how the price of gold declined after 1980. I answered one such query on this subject recently on the financial website Seeking Alpha where I am a contributor. You can read the question and my reply below.

What one must keep in mind for the time-frame of 1980 – 2000, there really wasn’t any competition to the U.S. dollar. With the introduction of the Euro, and soon thereafter ETFs that allowed investors to diversify their portfolios better, it drew away from the attractiveness of the U.S. dollar. Of course shipping all of our productive companies overseas didn’t help the GDP that allegedly backs the U.S. dollar either. There’s more to the story than just one issue such as inflation (the printing of money). Even the word “inflation” alone can cause confusion because some definitions don’t include the expansion or contraction of credit in the definition.

The article I commented on was Why Precious Metals And U.S. Treasuries Aren’t Good Bets Against The Current Uncertainty. It is a ridiculous title with no substance behind the article, but this comment by a Seeking Alpha editor caught my eye. There were replying to a comment from another poster, but I just had to chime in.

Comment from Seeking Alpha editor Jonathan Liss:

There was extreme inflation throughout the 80s, yet gold fell precipitiously. Please square this with your previous comment.

My reply;

Jonathan, you didn’t address this question to me, but I am not an inflation hawk as many of the other gold writers. I do see inflation in the future, but I am clearly in the deflation camp with inflation occurring in certain areas the past year (food and oil) but not so with real estate, which is why the banks are hurting so much.

In Roy Jastram’s book, “The Golden Constant,” he clearly laid out the observation that gold doesn’t maintain its purchasing power in inflationary times, but increases its purchasing power in deflationary times. But his analysis was flawed from a deflation perspective in the 1929-1933 period because the price of gold was fixed.

People are rushing to “perceived” wealth in U.S. treasuries and “real” wealth found in gold and silver. When interest rates start to rise again, and they will, and when inflation rears its ugly head, and it will, you can bet gold will be where people run to. Watch TBT, the 20 year treasury short for indication of the end of the treasury run.

But things can take longer than most expect. Just look at Japan which I have written extensively about. They lead the world in Debt to GDP ratio, before their recent triple disasters and yet the Yen is still “perceived” as strong. But they have something going for them that the U.S. doesn’t. They are a net exporter and they own about $750 billion of our treasuries. The U.S. on the other hand is a net importer and we owe trillions to other nations, let alone our own citizens. This can’t end pretty when/if people lose faith.

What will cause them to lose faith? Well, in Iceland they had better economic data than in the U.S. before their financial collapse. What brought them down? The banks.

The inflation/deflation debate becomes irrelevant when the banking system trumps it all. That’s why I keep close tabs on that sector. Someone hast too…

I know the typical retort from some to this, is higher interest rates will take people away from gold and into higher interest rate accounts. The Icelandic Krona fell 75% in one year and a 20% paying note didn’t keep pace with the fall. Greece is paying 80% on some of their notes according to Mish. A higher interest rate may not be enough.

Gold and silver give investors the insurance necessary to protect against any potential crack in the Humpty Dumpty economy. Those cracks can come from a multitude of places.

End

Afterthought

This debate about inflation and deflation can get complicated at times, but in reality, as I pointed out in my reply, the banks are what I keep an eye on most. We all know that our debt can’t be paid off by the taxes on the productive part of society. We all know politicians don’t get elected by saying they will raise your taxes (think Walter Mondale here). We all know there are troubles ahead for the economy because of this debt. But what we don’t know is how messed up the banks really are, especially the nations largest. The same can be said for Europe’s banks. That’s why I write about the banks, a synopsis and current thoughts about you can read in my most recent article; Only Precious Metals Can Prepare You For The Banking Crisis.

I will repeat…you never see any of the one’s calling gold a bubble, or criticizing gold speak to the banking crisis. No one.

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