Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
Inflation Consequences for the Stock Market, FED Balance Sheet - 24th Oct 21
To Be or Not to Be: How the Evergrande Crisis Can Affect Gold Price - 24th Oct 21
During a Market Mania, "no prudent professional is perceived to add value" - 24th Oct 21
Stock Market S&P500 Rallies Above $4400 – May Attempt To Advance To $4750~$4800 - 24th Oct 21
Inflation and the Crazy Crypto Markets - 23rd Oct 21
Easy PC Upgrades with Motherboard Combos - Overclockers UK Unboxing - MB, Memory and Ryzen 5600x CPU - 23rd Oct 21
Gold Mining Stocks Q3 2021 - 23rd Oct 21
Gold calmly continues cobbling its Handle, Miners lay in wait - 23rd Oct 21
US Economy Has Been in an Economic Depression Since 2008 - 22nd Oct 21
Extreme Ratios Point to Gold and Silver Price Readjustments - 22nd Oct 21
Bitcoin $100K or Ethereum $10K—which happens first? - 22nd Oct 21
This Isn’t Sci-Fi: How AI Is About To Disrupt This $11 Trillion Industry - 22nd Oct 21
Ravencoin RVN About to EXPLODE to NEW HIGHS! Last Chance to Buy Before it goes to the MOON! - 21st Oct 21
Stock Market Animal Spirits Returning - 21st Oct 21
Inflation Advances, and So Does Gold — Except That It Doesn’t - 21st Oct 21
Why A.I. Is About To Trigger The Next Great Medical Breakthrough - 21st Oct 21
Gold Price Slowly Going Nowhere - 20th Oct 21
Shocking Numbers Show Government Crowding Out Real Economy - 20th Oct 21
Crude Oil Is in the Fast Lane, But Where Is It Going? - 20th Oct 21
3 Tech Stocks That Could Change The World - 20th Oct 21
Best AI Tech Stocks ETF and Investment Trusts - 19th Oct 21
Gold Mining Stocks: Will Investors Dump the Laggards? - 19th Oct 21
The Most Exciting Medical Breakthrough Of The Decade? - 19th Oct 21
Prices Rising as New Dangers Point to Hard Assets - 19th Oct 21
It’s not just Copper; GYX indicated cyclical the whole time - 19th Oct 21
Chinese Tech Stocks CCP Paranoia, VIES - Variable Interest Entities - 19th Oct 21
Inflation Peaked Again, Right? - 19th Oct 21
Gold Stocks Bouncing Hard - 19th Oct 21
Stock Market New Intermediate Bottom Forming? - 19th Oct 21
Beware, Gold Bulls — That’s the Beginning of the End - 18th Oct 21
Gold Price Flag Suggests A Big Rally May Start Soon - 18th Oct 21
Inflation Or Deflation – End Result Is Still Depression - 18th Oct 21
A.I. Breakthrough Could Disrupt the $11 Trillion Medical Sector - 18th Oct 21
US Economy and Stock Market Addicted to Deficit Spending - 17th Oct 21
The Gold Price And Inflation - 17th Oct 21
Went Long the Crude Oil? Beware of the Headwinds Ahead… - 17th Oct 21
Watch These Next-gen Cloud Computing Stocks - 17th Oct 21
Overclockers UK Custom Built PC 1 YEAR Use Review Verdict - Does it Still Work? - 16th Oct 21
Altonville Mine Tours Maze at Alton Towers Scarefest 2021 - 16th Oct 21
How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
The Only way to Crush Inflation (not stocks) - 14th Oct 21
Why "Losses Are the Norm" in the Stock Market - 14th Oct 21
Sub Species Castle Maze at Alton Towers Scarefest 2021 - 14th Oct 21
Which Wallet is Best for Storing NFTs? - 14th Oct 21
Ailing UK Pound Has Global Effects - 14th Oct 21
How to Get 6 Years Life Out of Your Overclocked PC System, Optimum GPU, CPU and MB Performance - 13th Oct 21
The Demand Shock of 2022 - 12th Oct 21
4 Reasons Why NFTs Could Be The Future - 12th Oct 21
Crimex Silver: Murder Most Foul - 12th Oct 21
Bitcoin Rockets In Preparation For Liftoff To $100,000 - 12th Oct 21
INTEL Tech Stock to the MOON! INTC 2000 vs 2021 Market Bubble WARNING - 11th Oct 21
AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
Stock Market Wall of Worry Meets NFPs - 11th Oct 21
Stock Market Intermediate Correction Continues - 11th Oct 21
China / US Stock Markets Divergence - 10th Oct 21
Can US Save Taiwan From China? Taiwan Strait Naval Battle - PLA vs 7th Fleet War Game Simulation - 10th Oct 21
Gold Price Outlook: The Inflation Chasm Between Europe and the US - 10th Oct 21
US Real Estate ETFs React To Rising Housing Market Mortgage Interest Rates - 10th Oct 21
US China War over Taiwan Simulation 2021, Invasion Forecast - Who Will Win? - 9th Oct 21
When Will the Fed Taper? - 9th Oct 21
Dancing with Ghouls and Ghosts at Alton Towers Scarefest 2021 - 9th Oct 21
Stock Market FOMO Going into Crash Season - 8th Oct 21
Scan Computers - Custom Build PC 6 Months Later, Reliability, Issues, Quality of Tech Support Review - 8th Oct 21
Gold and Silver: Your Financial Main Battle Tanks - 8th Oct 21
How to handle the “Twin Crises” Evergrande and Debt Ceiling Threatening Stocks - 8th Oct 21
Why a Peak in US Home Prices May Be Approaching - 8th Oct 21
Alton Towers Scarefest is BACK! Post Pandemic Frights Begin, What it's Like to Enter Scarefest 2021 - 8th Oct 21
AJ Bell vs II Interactive Investor - Which Platform is Best for Buying US FAANG Stocks UK Investing - 7th Oct 21
Gold: Evergrande Investors' Savior - 7th Oct 21
Here's What Really Sets Interest Rates (Not Central Banks) - 7th Oct 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Will the Gold Bull Market Deflate?

Commodities / Gold & Silver Nov 23, 2007 - 12:19 AM GMT

By: Alex_Wallenwein

Commodities

Best Financial Markets Analysis ArticleOf course not. Ever tried deflating a balloon that hasn't been blown up yet? Kind of hard to do, isn't it?

When we think and talk about things, we often unknowingly accept and attach misleading labels to them, without giving it any thought at all. It's sort of a "garbage in, garbage out" principle. We accept a label others have unthinkingly given a subject, and then we run with it, which means by necessity that we are misapplying it.


It's just that way when we are thinking about gold and deflation.

The usefulness of the answers we get to our questions depend on how well we phrase our questions. Asking whether gold will 'deflate', for example, assumes that it can deflate in the first place. The question also doesn't really capture our main concern.

We don't care whether a gold bar we own will physically shrink in size. What we care about is whether, during a deflationary recession or an outright depression, its value will decrease to such an extent that it loses its utility as a hedge against untoward economic developments. That's kind of the nerdy way to put it.

The underlying concern is: "Will owning gold keep my wealth intact during a deflation?"

To answer that with any kind of intelligence, we have to first make sure we are talking about the same thing. So, the question arises: "What is a deflation"?

Most people think about deflation as a period of shrinking prices. Somehow we have all been taught to fear that - but why? If prices shrink, we can buy more with whatever money we have. Why should we fear that?

Obviously, shrinking prices alone are nothing to fear. Otherwise, we would recoil in horror every time we have to buy a new laptop computer and find out that the darn things became cheaper again! "Oh my God, what shall I do. Where will this all end up? What's the world coming to??"

Nobody reacts like that, right?

So, first of all, it's pretty clear that deflation can never exist without presupposing inflation - just like that silly analogy to the un-inflated the balloon above.

The problem lies in the fact that we have all been trained to accept the notion that inflation is inevitable, sort of like background radiation. We have no way to avoid exposure from radiation coming to us from the universe, so why worry about it? We also have no influence over the sad fact that most stuff gets more expensive most of the time, so we kind of resign ourselves to that as well.

However, inflation is far from inevitable as any gold buff already knows. It's only inevitable if we continue to live in a fractional reserve banking fiat system.

But we all do - so what now?

Most of the increase in apparent wealth we all see around us these days is probably in one way or another a direct result of the inflationary environment we live in.

  • 'Money' (aka debt-based legal tender) is created out of nowhere and circulates;
  • The law says we can buy stuff with it, so we all work hard to earn it or invest to increase it;
  • In the process of doing that, businesses decide to expand their operations by borrowing more - because it's cheap. Interest rates are low.
  • As a result, more 'money' is created as banks enter a 'credit' on the borrowing business' account;
  • Businesses hire more workers to ramp up production, more people make money and so can spend more, ramping up demand for the businesses' products, etc. etc.

Look around at all the shiny new cars everyone is driving, all the new restaurants, movie theaters, new buildings going up everywhere, and people improving their homes. Surely, we are better off than before, right?

Wrong. We are all indentured servants to our creditors, the banks. We have no savings. In the end, all of the glittery and new-looking stuff you see is just - borrowed. We just get to play with shinier toys than those we had before - but they really don't belong to us. They belong to the banks. Our individual, real wealth didn't grow at all. It shrank.

We like it that way, though, and we have all been trained to fear that it might stop someday. Now we are faced with the specter of "losing it all" because the artificially inflated economy might 'deflate.'

What is deflation, then?

A deflation is a credit contraction just like inflation is a credit expansion. Credit is debt, which means it must either be paid or defaulted upon.

When we are good little wage-serfs and pay our credit-masters what they have 'loaned' us (actually nothing), the masters are happy. Because the same people who control the banks that loaned us the money also control the media, the media tell us that we are wealthier, that we are 'better off', that we are 'happy.'

Oh, happy days!

But when we don't pay our masters, we become bad, bad people. They gave up nothing when they entered a 'credit' on our account after approving our loan. The law then allowed us to spend that 'nothing' as if it were real money, and now we have to work to earn more of that same mysterious 'nothing' to pay the bankers 'back' what they never really gave us in the first place.

Such re the mysteries of modern economic life.

Anyway, we have all been trained to regard this state of things as economic 'progress' and now we are faced with a recession.

Back to the real world.

We are living in the beginnings of a deflationary period. Credit is contracting all around us. Banks are even scared to loan money to each other.

The 'credit crunch' is nothing other than the result of homeowners being unable to pay off their mortgages. The mortgages are nothing but debt, but they represent cash flow - the contractual right to receive future payments.

These mortgages were sold to "investors" - mostly other banks - who use them as "assets" to entitle them to pyramid additional loans on top of them (banks are required to keep a certain loan-to-asset ratio which limits their ability to create deposits out of nowhere, so having "assets" is a good thing for them even if these assets in reality only consist of debt).

But now that debt is being defaulted upon, so the banks have to write them off as losses - which inevitably decreases their "asset-base" and therefore their ability to make loans.

And that means they can't make money by putting more people and businesses into debt.

So loans become more scarce, which means businesses can't finance their planned expansions as cheaply as before, so they cut back and lay people off who now don't have the income to make their mortgage payments, and the death-spiral continues.

As a result of all this, less 'dollars' (i.e., nothings) are created or they are created at a slower rate, and so less people have enough 'nothings' to support their spending habits, which reduces demand, and that, in the aggregate, causes prices to shrink.

That's why price deflation is so 'bad.' It gets people laid off.

Now back to our question: How does gold fare in such an environment?

Sorry. That's not really our question. Our question is: how does the purchasing power of gold fare in such an environment? We don't really care about gold. We care about how many 'nothings' we can sell it for so we can spend them on the stuff we need and want.

As prices for things drop, they drop for gold as well, so those who own gold are less well off and their friends who always thought they are kind of weird for wanting to own gold in the first place can turn their noses up at them and say: "Ptschhh! So what good does your gold do you now, huh?"

That's what gold owners are afraid of when they ask the question: "Will gold deflate?"

The real question is therefore: "Will the price of gold shrink in the same degree as prices of other things shrink during a deflationary period?"

Actually, that's not really the question, either. The real question is "will the purchasing power of gold decrease relative to the purchasing power of fiat during a deflationary period?"

Fiat becomes more "expensive" during deflations because it is harder to come by, either by working or by borrowing. Therefore its purchasing power increases. So, what about gold? Does its purchasing power increase as well, or does it remain static? If it remains static, holding cash is better and therefore people will sell their gold and cause the dollar-price of gold to drop further.

Before we answer that one, I have a counter-question for you: During inflationary times, do prices for all things go up the at the same rate?

No, they don't.

Look at the stock market and real estate bubbles. Look at health care. Look at rents and food prices. While stocks and real estate boomed and health care prices became a towering inferno, rents and food prices remained relatively stable, all the while prices for electronics decreased dramatically over the past ten to twenty years.

Well, the same thing is true during deflations. Not all prices fall at the same rate. Some prices might even rise as others fall or remain stable. So, which is it going to be for gold?

That depends. It depends on whether we believe the lie that gold is "just a commodity". We all know it isn't, but most people do believe that. The thing is that those who believe that nonsense usually don't own any gold, so their opinion has no effect on its price. They can't sell any.

The only people with any kind of impact on the price of gold are fund managers. Will they sell gold (or actually their contracts for gold or gold stocks that their funds own) during a deflation?That's where the reasoning takes an entirely new turn.

Because of the nature of their business and their holdings, fund managers have neither the incentive nor ability to hold actual cash. What fund managers are talking about when they say they hold cash is that their fund's money is invested in money market funds.

That's as far a cry from actual, physical cash as a gold option contracts are from gold itself.

Money funds are mutual funds that invest in short term, interest bearing debt instruments (what else is new in a world that revolves around debt?). Among the instruments they invest in are those of the commercial-paper variety.

"Commercial paper" comprises short-term debt instruments of the largest corporations around, many of whom are banks and other lenders and institutional investors - and one sub-group of what is known as commercial paper is so-called "asset-backed" paper.

Now, "asset-backed" means backed by mortgages - and many of those are of the sub-slime variety. That means commercial paper is now more risky than ever, and the deflation scenario we are examining assumed that the current credit crisis will continue and deepen.

The process of completely or largely weeding out subslime mortgages from the commercial paper markets is a long and tedious one that leads to lots and lots of companies losing their credit ratings - and those companies already include the world's largest banks.

What's a money market fund to do, then?

In such an environment, these funds are going to be looking to reduce their risk - and what do you think that means?

There are only two choices when it comes to risk reduction: Government securities - or gold.

If they pile into government securities, they drive up their prices and reduce their yields, which means lower interest rates, and that means 'dollars' (nothings) are getting cheaper to borrow again - and that, in turn, means credit inflation and mal-investment and all of the other associated evils.

But that was the root cause of the whole credit collapse in the first place, wasn't it?

Indeed.

Now, the real question is: Will they sell gold-related assets to buy those government debt securities, or will they liquidate other holdings to buy them? Frankly, in a risk-adverse environment, gold is still regarded as the most risk-free asset. It is the ultimate safe haven, and even the money managers know it.

Especially in the current and unbroken uptrend of gold, and in view of the fact that on an inflation-adjusted basis this six-year uptrend has not even led to gold recovering the 50 percent mark of its high in 1980, it would be foolish for them to trade astrongly appreciating, risk-free asset for riskier ones that promise lower returns.

To sum it all up: because gold is not "just" a commodity but is recognized (even by money-managers) as an excellent store of wealth in addition to being a form of money, and because risk-avoidance is the name of the game in a credit contraction, demand for gold will remain supported and its price will not suffer to the same extent as other prices in a deflating economy. (And then there is the international aspect of it all - but this article is already far too long. We will deal with that next week, maybe.)

In other words, gold is as good a form of wealth-insurance against catastrophic deflation as it is against catastrophic inflation. If you are convinced otherwise, you'll sell it prematurely at your own risk.

Got gold?

Alex Wallenwein
Editor, Publisher
The EURO VS DOLLAR MONITOR

Copyright © 2007 Alex Wallenwein - All Rights Reserved

Alex holds a B.A. degree in Economics and a juris doctorate in Law. His forte is research. In late 1996, he began to research how money is used by some to exert political and economic control over others' lives. In the process, he discovered that gold (along with silver) is the common man's antidote to this effort. In writing and publishing the Euro vs Dollar Monitor, he explains the dynamics of this process and how individuals can harness the power of gold in their efforts to regain their political and financial autonomy.

Just like driving your car, investing only makes sense if you can see where you are going. The Euro vs Dollar Monitor is the golden windshield wiper that removes the media's greasy film of financial misinformation from your investment outlook. Don't drive your investment vehicle without it!

Alex Wallenwein Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in