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.
gold and deflation
Gold And The Shrinking Money Supply
GOLD AND THE MONEY SUPPLY
A recent article (Credit Crunch: The Money Supply Has Shrunk For Eight Months In A Row) by Ryan McMaken of the Mises Institute explained clearly the historical significance of the contraction in the money supply that has occurred over the past eight months.
In this article, I will be talking about the possible effects of this ongoing contraction as they relate to the price of gold.
Gold Price Is Not About Gold
The gold price is not about gold. In fact, it tells us nothing about gold.
So why are people so obsessed with the price of gold? In most cases, it is because people likely view gold as an investment opportunity. “How much can I make and how quickly?”
However, the question which continues to plague gold investors and others is “Why didn’t gold respond the way we expected?”
The answer is found in the term unrealistic expectations.
When gold is characterized as an investment, the incorrect assumption leads to unexpected results regardless of the logic. If the basic premise is incorrect, even the best, most technically perfect logic will not lead to results that are consistent.
Here are some examples of inconsistencies when viewed through the lens of faulty logic based on incorrect assumptions…
Gold And Stocks Headed Lower
GOLD AND STOCKS HEADED LOWER – NO CORRELATION
Gold and stocks are moving south together; but they are not correlated. Nor, are they inversely correlated, as some gold enthusiasts claim.
Reference to gold as a safe haven has some investors buying gold to hedge against a stock market crash. It is almost as if gold has become a pseudo defensive stock.
It seems investors actually expect gold’s price to go up when the stock market goes down; and vice-versa.
If that were the case, how do you explain the extended periods when both moved together; or the price action of gold relative to stocks in the past four days? Gold currently is lower in price than it was before stocks tumbled nearly 4000 points.
Gold – Looking Back, Looking Ahead
GOLD – LOOKING BACK
Each year we are treated to calls for gold’s next big move. We heard it last year; and the year before, too. And the year before that. It may not be a broken record , but it is the same song.
Predictions for gold’s price are more than guesses, but they might as well be just guesses. That’s unfortunate, because no small amount of time is spent trying to analyze gold. And it is time wasted.
Gold Prices – Inflation vs. Deflation
GOLD PRICES
Inflation is the debasement of money by government. The expansion of the supply of money and its subsequent loss in value results in an increase in the general level of prices for goods and services.
Deflation is characterized by a contraction in the supply of money and a decrease in the general price level of goods and services. (What we are currently experiencing is called ‘disinflation’ which is a lower rate of inflation.)
The purpose of this essay is to clarify and explain accurately what to expect regarding gold prices if deflation occurs.
According to Wikipedia: “Inflation reduces the real value of money over time, but deflation increases it. This allows one to buy more goods and services than before with the same amount of money.”
The United States Government, via the Federal Reserve Bank, has been practicing inflation regularly for over one hundred years. They are good at it. Their efforts have resulted in a ninety-eight percent “reduction in the purchasing power per unit of money.”
The reduction in purchasing power of the U.S. dollar is reflected in the higher price of gold.
In 1913, with gold at $20.65 per ounce, twenty U.S. dollars in paper money was equal to twenty dollars in gold. Today gold is at $1270.00 per ounce, more than sixty times higher than in 1913.
The higher price for gold does not mean that gold has experienced an increase in purchasing power. Rather, its higher price reflects the decline in purchasing power of the U.S dollar.
Deflation is different. It is the exact opposite of inflation. And the results are different as well.
As we said earlier, deflation is characterized by a contraction in the supply of money. Hence, each remaining unit is more valuable; i.e. its purchasing power increases.
Government causes inflation and pursues it for its own selfish reasons. A government does not voluntarily stop inflating its currency. And it certainly isn’t going to reduce the supply of money. So what causes deflation?
Government causes deflation, too. Deflation happens when a monetary system can no longer sustain the price levels which have been elevated artificially and excessively.
Governments love the inflation they create. But with even more fervor, they hate deflation. And not because of any perceived negative effects on its citizens. It is because the government loses control over the system which supports its own ability to function.
Regardless of the Fed’s attempts to avoid it, deflation is a very real possibility. An implosion of the debt pyramid and a destruction of credit would cause a settling of price levels for everything (stocks, real estate, commodities, etc.) worldwide at anywhere from 50-90 percent less than currently. It would translate to a very strong US dollar. And a much lower gold price.
Those who hold US dollars would find that their purchasing power had increased. The US dollar would actually buy more, not less. But the supply of US dollars would be significantly less. This is true deflation, and it is the exact opposite of inflation.
The relationship between gold and the US dollar is similar to that between bonds and interest rates. Gold and the US dollar move inversely. So do bonds and interest rates. If you own bonds, then you know that if interest rates are rising, the value of your bonds is declining. And, conversely, if interest rates are declining, the value of your bonds is rising. One does not ’cause’ the other. Either result is the actual inverse of the other.
Inflation leads to a U.S. dollar which loses value over time; hence, this is reflected in a higher gold price.
Deflation results in an increase in value/purchasing power for the U.S. dollar; hence, this is reflected in a lower gold price.
Those who expect gold to increase in price during deflation are wrong for several reasons.
Gold is not an investment. And it does not respond to the various headline items that journalists and analysts continue to repeat erroneously. It is not correlated with interest rates and it does not respond to housing statistics. It is not influenced by world events, terrorism, or the stock market.
Gold is real money. The U.S. dollar is a substitute for real money, i.e. gold.
If deflation occurs, there is no other possibility except for lower gold prices.
(to read more about gold and its relationship to the U.S. dollar, see here)
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!