Among the myths being constantly circulated by gold bears is that gold (and silver)
perform well in high-inflation environments. As with many of the pronouncements of the gold bears, this is another case of them drawing conclusions based upon their own faulty understanding of markets, history, and precious metals, themselves.
To properly understand this issue requires understanding the true nature of money. While I have covered this issue in a previous commentary, this concept is so important, and so few people understand it that it is worth explaining this point again. The starting point is to list the four properties that all good "money" must exhibit:
4. A store of value
A "store of value" is a concept that is pretty much self-explanatory. The historical measurement of gold as a store of value is that an ounce of gold has traditionally been enough to purchase a fine suit for a man. That is a standard that is centuries old, providing a concrete example of how gold has held its value.
Conversely, in the less than 100 years in which the
has been entrusted with protecting the U.S. dollar, it has lost about 97% of its purchasing power. Gold is a store of value. Paper currencies are not.
3. Evenly divisible
Good money must also be evenly divisible. In past eras, other valuable items have been used intermittently as money, with gemstones being one example. While such "hard assets" pass the test as a "store of value," gemstones are
evenly divisible. While any one particular gem could be split into equal parts, collectively it is impossible to divide all gems into equally sized units. Gold and silver, on the other hand, are malleable -- and easy (even for primitive societies) to fashion into evenly-divided parts.
Good money must also be uniform, that is, any two units of money should be identical in quality/purity. Again, many items of value that have been tried as money in the past proved to be impractical because they failed this "test," and gemstones would again be an example of this. Because all are not of equal quality, they make an inferior form of money because all units would not be accepted equally as payment for goods.
1. Relatively rare
Lastly, good money must be relatively rare. Spices, and even ordinary salt, were used as money in many ancient cultures. However, as trade grew, and spices began to be cultivated/produced in large amounts, spices became inadequate as money, because potential sellers would be unwilling to surrender their goods for a supply of money that could be produced in near infinite amounts.
Upon seeing this definition, it should be obvious to people that the paper currency we carry in our wallets is not "money." Essentially, what banker-dominated governments have done is to eliminate two of the basic properties of good money (that it is "rare," and a "store of value") and then attempted to pawn off their own scraps of paper as "money" -- simply because the scraps of paper are uniform and evenly divisible. Thousands of years of history teach us that "money" that does not satisfy all four, mandatory criteria is doomed to extinction. Thus, the current rise in value of gold (and silver) is only partially due the inflationary impact on gold and silver as commodities.
Precious metals: A hedge against inflation ... and deflation
The primary "driver" of gold and silver today is the fact that (as always happens) gold and silver are reasserting themselves as the best form of "money" our species has been able to devise in 5,000 years. This is the aspect of precious metals which is completely beyond the comprehension of the gold-bears. However, once we understand what money really is, and why gold and silver are the best forms of money ever devised, it should become obvious why precious metals will thrive in either inflation- or deflation-dominated economies.
Keep in mind that all that "high inflation" really means is that the value of a currency is collapsing. All goods don't suddenly become more valuable, but rather the "money" we use to pay for those goods has lost its value. Generally, high inflation is caused by excessive money-printing; so we could say that the reason why gold and silver soar in value during high inflation is because it causes the realization that the scraps of paper are neither "rare," nor a "store of value". In other words, what happens is there is a crisis of confidence with respect to paper currency, with the consequence being that people want to rid themselves of paper currency, in favor of money (i.e. gold and silver).
What the gold-bears either can't understand (or simply choose to blind themselves to) is that deflation also causes a crisis of confidence - in any economy which has been foolish enough to sever its monetary system from a "gold standard." This may not be immediately apparent, so I will explain the dynamics.
With a gold standard, paper money must be at least partially redeemable in real bullion. This requirement protects a currency in times of deflation -- because people know that no matter how badly an economy sags that their money is "backed" by a hard asset.
In contrast, today (for the first time in history) the entire world is operating with purely "fiat currencies." For those unfamiliar with the term, this means currency that only has value through a declaration (or "fiat"). The only reason why people can buy goods with a U.S. dollar (or other unit of currency) but could not purchase goods with "Monopoly money" is because of a decree that one scrap of paper has value, but another does not.
Lacking the backing of any hard asset, the only intrinsic value of a paper (fiat) currency is indirect: through viewing units of currency as essentially government IOUs, which would ultimately be "backed" by the underlying wealth of an economy. Given this additional context, it should start to become clear why a serious deflation again causes people to dump paper currencies, in favor of gold and silver money: because of a fear of insolvency.
With gold backing, currency is a "secured" asset. Without gold backing it, all paper currencies are nothing but unsecured IOUs. Naturally, anyone sitting with unsecured assets is going to be severely tempted to dump those assets when a fear of insolvency arises.
With the general fundamentals now explained, it's time to apply those fundamentals to current parameters. More specifically, it's time to analyze how gold (and silver) will react as the hopeless insolvency of the U.S. becomes obvious to more and more people.
The U.S. is facing bankruptcy
For those who have not read my previous work, I'll reiterate why the U.S. is facing inevitable bankruptcy. To begin with, the U.S. economy is currently carrying roughly $60 TRILLION in total public and private debt. This does not include the additional $70 trillion (or so) in "unfunded liabilities." These debts and liabilities far exceed the debts and obligations of all the rest of the world, combined.
The "unfunded liabilities" alone represent trillions of dollars per year that the U.S. economy has no hope of ever being able to fund through revenues. There are two reasons it's not even theoretically possible for the U.S. to avoid being crushed by its massive debts.
First, the Obama regime itself is now predicting that over the next decade half of its projected increase in debt will be just interest payments on current debts. Every year, a larger and larger portion of every revenue dollar gets consumed by interest payments. Thus, as a matter of elementary arithmetic, it is totally impossible for the U.S. economy to ever grow as quickly as it has in the past - and every year that maximum growth level will shrink further.
With the U.S. government basing its farcical budget projections on above-average growth of the U.S. economy, in the real world its economic growth must trend in the opposite direction, as a matter of arithmetic. However, the even more certain reason why U.S. default is guaranteed is because its totally inflexible and hopelessly gridlocked political system is incapable of ever generating the sort of massive spending cuts that would be needed just to seriously delay U.S. bankruptcy (see
The more obvious means of demonstrating U.S. insolvency is through the once-a-year "deficit" calculation by the Treasury Department, using GAAP accounting ("generally accepted accounting principles). This is the form of accounting required by law for all corporations.
Using proper accounting methods, the U.S. had average, real deficits of over $4 trillion per year throughout the entire eight-year reign of George Bush Jr. (as calculated by the Treasury Department). The real deficit for 2008 was $5.1 trillion. We don't know what the real deficit was for 2009 -- because the Treasury Department has refused to publish its report (even though it is mandated by law).
It is supposed to be released each November, but the Treasury Department is saying that it won't release the report until February. Personally, I'll believe that when I see it. Despite the fact that the U.S. media totally ignore the only accurate budget calculation of the U.S. government, it's not surprising that the U.S. government wants to hide this information from the small number of commentators who do report it.
With U.S. government spending soaring at the same time that government revenue are collapsing, the real deficit for 2009 will be far higher than the $5.1 trillion deficit for 2008. John Williams, who calculates accurate economic statistics for the U.S. economy at Shadowstats.com, is expecting the 2009 deficit to approach $9 trillion.
The U.S. economy has a negative net worth. Its cash flow is hopelessly inadequate to meet future spending requirements and it has demonstrated (over a period of decades) that its political system is completely incapable of the sort of radical, fiscal reforms necessary just to delay bankruptcy. With the U.S. dollar also now totally severed from any connection/backing with precious metals, then obviously the current (real) value of a U.S. dollar is zero.
As the U.S. economy begins its next leg down (and a "leg" certain to be even more painful than the initial collapse), and as the U.S.' previously deluded creditors begin to comprehend the magnitude of U.S. insolvency, no one will want to hold U.S. dollars -- and everyone will want to hold gold and silver.
The terminal value of paper currency is zero
In a high-inflation environment, a currency moves relentlessly but gradually toward a value of zero. Conversely, in a solvency crisis, a currency can go to zero overnight. Thus, instead of a deflationary environment being "bearish" for gold, it is arguably even more bullish than a high-inflation scenario.
There are many commodities that will soar in value as the wave of inflation caused by insanely reckless money-printing leads to the worst global inflation in at least three decades. Simultaneously, the U.S. and a few other hopelessly insolvent economies are facing deflationary spirals combined with high inflation for basic consumer goods - the "hyperinflationary depression" that John Williams has been warning Americans about for most of this decade.
The only asset class with fundamentals that will allow it to thrive in inflation and deflation are precious metals. Those investors foolish enough to listen to the deluge of anti-gold propaganda will not be prepared for the events to come. Educate yourselves and protect yourselves before the next panic begins.
At the time of publication, Nielson was long gold and silver bullion.
Jeff Nielson studied economics for four years at the University of British Columbia, before going on to attain a law degree from that same institution in 1989. He came to the precious metals sector around the middle of last decade as an investor, but quickly decided this was where he wanted to focus his career. After publishing his own, amateur blog for a year, in 2008 he founded Bullion Bulls Canada: a web-site providing information and analysis to precious metals investors. Today, bullionbullscanada.com reaches a global audience of precious metals investors in more than 120 countries.