NOTE TO READERS: “Global Credit Collapse Is Deflationary” was originally published as an exclusive for TalkMarkets on October 29, 2024. I have not changed anything in the article, nor is there any reason to modify or alter what is written below because of U.S. election results.
deflation
Viewing Gold In Its Proper Context
Viewing gold in its proper context seems to be difficult for most gold bugs. The excitement associated with anticipation of gold at $3000, $10,000, or higher tends to overide real fundamentals and common sense.
Not a few of the predictions for a new, higher gold price are just wild guesses. Some of the reasons given to support those guesses include a Fed pivot and reduction in interest rates, geopolitical concerns, a recession and weak economic activity, and a collapse in the U.S. dollar. There are others, but for now, lets look at these.
GOLD AND INTEREST RATES
Financial writers in the media continue to refer to “gold’s correlation with interest rates”. The theory is that higher interest rates are negative for gold (the gold price) because gold doesn’t pay interest. Hence, investors tend to shun gold when interest rates are rising and look elsewhere for a higher return.
Time and again, the following statement or something similar finds its way into gold commentary:
“…prospects of higher US interest rates have the ability to limit upside gains. It must be kept in mind that Gold is a zero-yielding asset that tends to lose its allure in a high-interest rate environment”
A variation of that statement:
“Because gold doesn’t bear interest, it struggles to compete when interest rates rise.”
The statements imply a correlation between gold and interest rates. The implied correlation suggests that higher interest rates result in lower gold prices, however…
Between 1970 and 1980, the price of gold increased from $35.00 per ounce to $850.00 per ounce. Rather than declining, though, interest rates were rapidly rising.
Gold galloped ahead in the face of ever higher interest rates and increasing lack of demand for higher-yielding investments including U.S. Treasury Bonds. The 10-year U.S. Treasury bond yield exceeded 15%!!! This contrasts markedly from what happened thirty years later.
During the ten-year period 2001-2011, the price of gold increased from $275.00 per ounce to a high of almost $1900.00 per ounce. Yet, interest rates, which had been declining since the 1980s, continued their descent (helped along by the Fed, of course).
Two ten-year periods of outsized gains in the price of gold while interest rates were doing something exactly opposite during each period. There is no correlation between gold and interest rates.
GOLD AND GEOPOLITICAL CONCERNS
Any apparent effects from geopolitical issues are temporary at best, and there is no reason to expect them to have any measurable or lasting impact on the gold price unless the U.S. dollar is affected negatively.
(See my article The Gold Price And Geopolitical Concerns for examples; i.e., Russia vs. Ukraine, Israel vs. Hamas, The War with Iraq, etc.).
GOLD AND RECESSION FEARS
A recession is a period of weak economic activity. Even a severe recession will not have an appreciable effect on the gold price.
If the recession deepens and economic activity declines severely, the result could be a full-scale depression.
In most cases, events of this nature are accompanied by deflation. Deflation is the opposite of inflation and results in a stronger currency (USD) which gains in purchasing power.
The gain in purchasing power means you can buy more with your dollars – not less. The downside is that there are fewer dollars to go around. There would be a huge price collapses in prices for all assets, investments, goods and services. The gold price would be similarly affected.
GOLD AND DOLLAR COLLAPSE
There are expectations by some for a complete collapse in the U.S. dollar resulting in hyperinflation; similar to Germany in the 1920s, Zimbabwe, or Venezuela.
That is possible, but it is unlikely. A credit collapse and deflation are more likely since the Federal Reserve fuels inflation with cheap credit. A credit collapse would trigger huge price declines in all assets, including gold. The most likely result would be a full-scale depression that could last for years.
Even if the U.S. dollar were to collapse, the price of gold in dollars would be meaningless.
VIEWING GOLD IN ITS PROPER CONTEXT
Gold is real money and a long-term store of value. It is also original money. Gold was money before the U.S. dollar and all paper currencies; and, all paper currencies are substitutes for gold, i.e., real money.
The higher price of gold over time reflects the ongoing loss of purchasing power in the U.S. dollar. In other words, the price of gold tells us nothing about gold.
The gold price tells us only what has happened to the U.S. dollar. The same thing is true if gold is priced in any other fiat currency.
Over the past century, the dollar has lost ninety-nine percent of its purchasing power. This means that it costs one hundred times more for the things you buy today than it would absent the effects of inflation.
The original fixed price of gold was $20.67 oz. Convertibility allowed exchange of $20.00 in paper money for one ounce of gold and vice versa.
At $2000 oz., gold today is one hundred times higher and reflects the actual ninety-nine percent loss of USD purchasing power.
The gold price only moves higher to reflect the dollar’s loss of purchasing power after the fact; never before.
Expectations for a much higher gold price based on anything other than the loss of U.S. dollar purchasing power will not be realized.
A much higher gold price can only present itself after further, significant loss of U.S. dollar purchasing power.
Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED!
Destruction Of Money Keeps Inflation In Check
DESTRUCTION OF MONEY
The “biggest collapse in the money supply since the Great Depression” continues unabated at this point. (See Ryan McMaken’s article here.)
The decline in the money supply is nearly three years old and dates back to April 2021.
This decline is a destruction of money and is the opposite of what might be expected if one is looking for evidence that could support some of the more extreme expectations and projections for inflation and its effects.
That is because most, if not all, of the analysis about inflation and its effects focuses on the supply of money and its seemingly unlimited growth.
Discussion about money creation by governments and central banks almost universally excludes mention of the demand for money.
DEMAND FOR MONEY
Money has a demand side, too. We are not talking about the demand for goods and services. We are talking about the demand for money, itself. People need money to pay taxes and transact business; to save and invest.
As long as the supply of money is relatively stable and sufficient to finance existing normal economic activity, then the result is price stability. Without price stability, the economy cannot function reasonably.
Since the inception of the Federal Reserve, excessive growth in the money supply has led to a ninety-nine percent loss of purchasing power in the U.S. dollar.
Currently, though, the money supply is not growing. It is shrinking.
A SHRINKING MONEY SUPPLY
A shrinking money supply is directly opposite to that which has happened which has made the U.S. dollar nearly worthless compared to a century ago.
It is also not supportive to arguments that the U.S. dollar is about to collapse and that hyperinflation is on the way.
Without the continual infusions of “new” money, the previous inflationary “highs” cannot be maintained, let alone increased.
If a shrinking money supply continues, the end result is deflation. (see An End To Inflation – Three Possibilities)
WHAT IS DEFLATION?
Deflation is the exact opposite of inflation. The result is a stronger currency. Instead of losing purchasing power, your dollars would buy more – not less.
Deflation is not bad. However, some of the accompanying economic effects would be very difficult to endure. The U.S. dollar would go further, but there would be fewer dollars to go around.
There would be huge price reductions in real and financial asset prices, depressed economic activity and high unemployment. Conditions would rival and probably exceed those of the Great Depression of the 1930s.
Fortunately, at least for now, we are not there yet.
CONCLUSION
An infusion of new money might temporarily reverse the shrinking money supply and its negative economic effects, but that is not necessarily a good thing.
Think of it this way. Would you recommend a new fix to a drug addict who is undergoing withdrawal symptoms resulting from curtailing their drug use and attempting a return to sobriety?
Intentional inflation by government and central banks in the form of cheap and easy credit has created artificial financial highs, bubbles in asset prices, and a false sense of economic security.
You cannot ignore fundamental financial and economic law forever. Sooner or later (more likely sooner), we will all pay the price. (also see Gold And The Shrinking Money Supply)
Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED!
Demand For Money Could Cause Deflation
BANKING CRISIS = LIQUIDITY CRISIS = DEMAND FOR MONEY
Events this past week are indicative of what could be a more formidable problem for the Fed, investors, and the economy. Before we talk about that, lets first emphasize the key point made in my article SVB, MMT, TNT.
What happened at Silicon Valley Bank, Signature Bank, and now, Credit Suisse and First Republic banks, are not individual issues. All of them are the obvious signs of banking system fragility due to the practice of fractional-reserve banking. Therefore…
What has been termed a banking crisis is actually a liquidity crisis; and the loss of liquidity translates to a DEMAND for money.
Default – Deflation – Depression
DEFAULT – DEFLATION – DEPRESSION
Inflation is the primary game plan of governments and central banks. Its effects have left their mark on societies throughout history. As the effects of inflation continue to dominate headlines, financial and economic activity is scrutinized and analyzed with the intent of planning, projecting, and predicting it.
Most people think they understand inflation – they don’t – but for now, let’s look the other way. There is a triple-decker bus coming straight at us.
No Fear Of Inflation; Threat Of Deflation
FED HAS NO FEAR OF INFLATION
The Fed wants to have their cake and eat it too, but the cake is stale. Jerome Powell’s remarks in testimony before the Senate recently provoked considerable attention.
Responses, interpretation, and analysis by observers were many and varied. Unfortunately, no one learned anything different from what they thought they knew before Powell’s testimony.
The Fed is well aware of the problem. It is systemic in nature and goes far beyond corporate due diligence, bank liquidity, and the safety of your broker.
Most everyone else (with the exception of Janet Yellen, Ben Bernanke, and Alan Greenspan) thinks they understand the problem, but their limited understanding doesn’t allow for the subtleties of Fed Chair behavior.
Asset Price Crash Dead Ahead
An All-Asset Price Crash (AAPC) might be the next “Wow! Can you believe it?”
In the meantime, whether it be stocks, bonds, gold, or oil, investors are licking their chops and counting their profits before they are booked. And, they have reason to gloat. Let’s see what all the noise is about.
Cash Is King Right Now, Not Gold
CASH IS KING FOR NOW
Amidst the fallout of stock markets crashing worldwide, gold (silver, too) and oil imploding, and the scare of coronavirus, the dollar itself stands tall. That is not what some were expecting. Nevertheless, unrealistic expectations abound today, so let’s see what we can learn from this.
When investors sell en masse, they generally turn to cash as a resting place for their money. Cash for most people today still means US dollars. This implies an increase in demand for US dollars. Gold investors and their advisors seem to have been expecting just the opposite.
Gold Price – US$700 Or US$7000?
Does either of the above preclude the other? In other words, if we expect gold to reach $7000.00 per ounce, and we are correct, does that mean that we can’t reasonably expect gold to go as low as $700.00 per ounce? Conversely, if we are predicting or expecting gold to decline from its current level and even breach $1000.00 per ounce on the downside, can $7000.00 per ounce, or anything even remotely close to that number, be a reasonable possibility?
How Government Causes Inflation
We know that inflation is the debasement of money by government. The effects of inflation show up in the form of rising prices over time. The rising prices are a reflection of the loss of purchasing power of the currency involved. For our purposes, that means the U.S. dollar.
The chart below depicts increases in the Consumer Price Index, year-to-year, dating back to 1914…