What Does the Price of Gold Do In Deflation? UPDATED 10/12/2010

Frank Holmes, CEO and chief investment officer at U.S. Global Investors, recently wrote an article “Gold and Deflation.” In this article, Holmes came to the following conclusions;

1. Interest earned on 90-day Treasury bills below the inflation rate is a signal for governments to try to stop deflation and reflate the economy.

2. During these periods, governments usually need to increase their deficits by escalating their borrowings to support the economy.

3. Both of these are occurring or being implemented in the U.S., and thus deficit spending puts downward pressure on the dollar. And when the dollar falls, investors tend to turn to gold.

In reading this article, I really didn’t see any conclusions as to deflation and how it relates to gold except for the fact that the effects of deflation causes more government intervention/printing, and thus inflation, which in turn can be good for gold.

But what about the price of gold in deflation?

The first thing that will come to people’s mind when they read that question is, “what deflation?”…”Are you nuts?”…”It’s inflation that’s occurring!” This issue will be addressed later in the article. But when it comes to answering the question, “What does the price of gold do in deflation,” we really don’t have many historic examples here in the U.S. But the U.S. 1929-1932 deflationary episode can shed some light and coupled with an analysis of Japan’s ongoing deflationary episode we can possibly come to some conclusions.

The following three areas will be discussed in trying to decipher what the price of gold will do during deflation;

1. An analysis of Roy Jastram’s observations on gold and deflation.

2. A closer look at the 1929-1932 U.S. deflationary era and the possible flaw in Jastram’s analysis.

3. An analysis of what has happened with gold priced in Yen during the last decade of Japanese deflation.

Roy Jastram’s Analysis of Deflation and Gold

Roy Jastram is the author of the epic book on what happens with gold in  deflation and inflation called, The Golden Constant: The English and American Experience, 1560-1976. In this book he showed the following effect on the purchasing power of gold during three deflationary episodes.

Deflationary Periods

1814-1830 – Prices fell 50%, Purchasing Power of Gold
increased 100%

1864-1897 – Prices fell 65%, Purchasing Power of Gold
increased 40%

1929-1933 (Great Depression Era) Prices fell 31%, Purchasing Power of Gold increased 44%

In all of these cases, the purchasing power of gold rose during these deflationary episodes.

The Flaw in Jastram’s Analysis of Deflation and Gold; The U.S. 1929-1932 Deflationary Episode

When looking at the analysis that Jastram did of the 1929-1933 era, he concluded that prices fell and the purchasing power of gold actually increased. But is this analysis accurate?

The problem with Jastram’s analysis is the price of gold was fixed during this era at $20.67 an ounce as seen in the following chart.

During the 1929-1933 era, Murray Rothbard points out in his book, The Great Depression that “from the end of 1929 to the end of 1931, the FRB index of production of durable manufactures fell by over 50%, while the index of non-durable production fell by less than 20%.” Subsequently, wholesale prices fell 30.8 percent, and consumer prices fell 24.4 percent during this era.

Naturally, if you have a fixed gold price and prices fall, an ounce of gold will buy you more of the lower priced goods.

So if Jastram made the observation that the purchasing power of gold increased during the 1929-1933 era, he of course is right. But does one not need to take into account  the price of gold was fixed during this era?  Gold could have performed much better if it was allowed to trade freely.

What Would the Price of Gold Have Done in 1929-1932 if Allowed to Trade Freely?

The question that needs to be answered then is, what would the price of gold have done during the 1929-1933 deflationary episode if it were traded freely? If people were rushing to the bank to demand gold coin for their Federal Reserve Notes, the price of gold would have naturally moved higher. I don’t think anyone doubts that this would have occurred. Banks were failing at an alarming rate and people were running to the real wealth represented by gold.

Since we only can go back in time and make assumptions, the answer as to what the price of gold might have done during this era can possibly be found in what has occurred with Japan the last decade or so during their current deflationary experience.

Gold, the Yen and Japanese Deflation

While Ben Bernanke and others at the Fed lament on how the Fed will escalate their borrowing via QE2, which in fact would result in monetary inflation, the price of gold has moved higher of late. But all this has resulted in so far is just talk. The Fed hasn’t actually done any quantitative easing of late. That’s all the Fed can do, is talk the talk. This is exactly what Bernanke said he would do in his infamous speech; Deflation: Making Sure “It” Doesn’t Happen Here.

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.

And people believe him, hence the recent run up in gold even higher. I don’t believe him because I think it is deflation he is worried about. Understand, this doesn’t mean the price of gold can’t go higher as this article will reveal.

In the U.S., at present, we are experiencing an inflationary bump in an overall deflationary credit contraction. Not too long ago, the U.S. dollar was rising and there was no signs of inflation. Yet the price of gold was rising right along with it. Why is that?

What reasoning did the inflation hawks have for the price of gold moving higher when there were no signs of inflation? Was it the threat of future inflation that was moving gold higher? Possibly. But why was the dollar moving higher at the same time? The truth is, there were plenty of signs of deflation occurring.

The effects of the deflationary contraction we were experiencing then resulted in the purchasing power of gold increasing as it bought more goods and services than when prices were higher. This was a good thing. This confirms Jastram’s conclusions, as long as the price of gold stayed somewhat constant or was rising.

In the Feds attempt to stimulate, which is clearly just allowing the economy to “hang in there a bit longer,” they have failed to increase productivity or for that matter decrease unemployment. Naturally they will continue to try and stimulate the economy as Bernanke perceives this will eventually work. But all of this stimulating is being dwarfed by the credit contraction that is occurring. This begs the question; Can the Federal Reserve Prevent Deflation?

This is where the gold bugs cringe. But bear with me gold bugs…

Naturally dropping money from helicopters and purchasing debt will “make sure it (deflation) doesn’t happen here,” but at what cost to the economy and the U.S. dollar? Does anyone believe this is what the Fed wants to happen; to destroy the economy with the higher rates that would come and decimate the housing market? What would that do to the banks? Lenders? The average Joe who owns a home? I’m simply calling Bernakne’s bluff.

The Japanese Example

This is exactly what has been happening in Japan the last decade. The Japanese government has been stimulating and at present the Japanese have the highest Debt to GDP ratio in the world at approximately 227%.  Please see; Is the U.S. Following in Japan’s Deflationary Footsteps?

But what has occurred in Japan with the Yen is that it has become stronger versus most other currencies. This does show that despite the continued Japanese government spending, the credit contraction of the inflationary years in Japan has caused a rush to perceived safety in the Yen as the stock markets and real estate markets deflated.

This appreciation in the Yen of course won’t last. Since the world wide recession the Japanese exports have fallen significantly with the decline in production and subsequent slowdown in GDP growth. The Japanese, whose citizens have traditionally bought their own debt could soon be unloading that debt on foreigners and looking for the last bastion of wealth; gold and silver. Could this be the eventual outcome in the U.S.?

How Will Gold Perform In a Deflationary Period?

To finally answer the question on how gold will perform in a deflationary period, the follow charts show gold has appreciated 279% priced in Yen the last 10 years and 6.1% the last 60 days.

Who Says Deflation Is Bad for the Price of Gold?

We are still in the second and longest stage of this gold bull market and when or if the U.S. dollar rises, priced in other currencies as revealed by the U.S. Dollar Index, there could be a decline in the price of gold. Barring any external influences, the Elliott Wave folks seem to think this will occur. But they haven’t had a good track record with gold because they don’t account for external influences. So they keep drawing new lines and changing their projections.

Market makers will always try and buck people off the trend, but they have had a difficult time bringing gold down. People are waking up to what the government and the Federal Reserve are doing to our money. Supply and demand will become more and more an issue.


A holder of physical gold cares not that it falls 20% on its way to $2,000 and higher. Dollar cost averaging into a position on any downturn in price makes good sense as the Japanese deflationary example has shown.

Look for the U.S. and Bernanke to follow the Japan example and possibly double the Debt to GDP ratio, and look for gold to maintain its strength during this deflationary credit contraction. Today, unlike 1929-1932, there’s no “fixing” of the price of gold.

I go into the deflationary credit contraction outlook in Chapter 4 of my book, Buy Gold and Silver Safely. With 100 footnotes from the Austrian economic perspective, including the viewpoints of Professor George Reissman, PhD, Pepperdine and Steve Keen, PhD, University of Western Sydney, and many others. The title of chapter is; Credit Expansion->Inflation->Bubble Bursts->Recession>Government Intervention->Unemployment->Credit Contraction and Deflation->Banking Crisis->Hyperinflation->Depression.

While there are some on the Austrian side who never address deflation, namely Gary North and Peter Schiff, I simply ask, why are treasuries doing so well? If things were so bad, then wouldn’t money be running out of treasuries? We’re not there yet.

The fact of the matter is, the trillions of dollars of paper wealth are flowing down to perceived wealth (U.S. treasuries) and real wealth (gold and silver). Treasuries are stronger in spite of all the quantitative easing that has occurred.

The dollar, priced in other currencies via the Dollar Index, doesn’t paint the correct picture. Gold has appreciated against all currencies by 160% or more the last 10 years. Yes, even the Australian Dollar and the Swiss Franc.

In the end, Homes, Schiff and North et al. will all be proven right. But so will those who see thelight of a deflationary credit contraction. In the end, gold will shine.

Go To Buy Gold And Silver Safely Store
About Doug Eberhardt

Doug Eberhardt is a 28 year financial services veteran and precious metals broker selling gold and silver at 1% over wholesale cost. Doug has written a book to help investors understand how gold and silver fit into a diversified portfolio, how to buy gold and silver, and what metals to buy. The book; “Buy Gold and Silver Safely” is available by clicking here Contact phone number for Buy Gold and Silver Safely is 888-604-6534


Commodity Futures Trading Commission Futures and Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the futures and options markets. Don’t trade with capital you can’t afford to lose. This is neither a solicitation nor an offer to Purchase/Sell futures or options. No representation is being made that any account will or is likely to achieve gains or losses similar to those discussed in this outlook. The past track record of any trading system or methodology is not necessarily indicative of future results.

All trades, patterns, charts, systems, etc. discussed in this outlook and the product materials are for illustrative purposes only and not to be construed as specific advisory recommendations. All ideas and material presented are entirely those of the author.


Leave a Comment

Your email address will not be published. Required fields are marked *