Is this the time to acquire gold? Or is this the time to run away from it?
Either answer could be correct, depending upon what course government chooses. Government is at a decision point, one that will determine how our economic malaise next turns. It has two choices:
- Fight deflation by increasing the money supply by whatever amount necessary.
- Stop using monetary policy to offset the inevitable.
The first choice aims at holding prices up in the face of a massive contraction in liquidity as the debt structure of the country shrinks, primarily via defaults. Even if this course is chosen, it is not certain that the rate of liquidity collapse will be offset by the creation of new liquidity. Government is clumsy and inept. Any attempt to counteract deflation risks inflation, perhaps hyperinflation. It is a choice fraught with potential unintended consequences.
The second choice accepts whatever level of deflation results as an inevitable outcome of past excesses. It abandons an expansionary monetary policy and faces the reality that a correction is both inevitable and necessary in order to return the economy to health. It will produce a Depression which purges the economy of the imbalances and misallocations which developed as a result of decades of government interventions.
Regardless of which choice is made, a Depression is ultimately inevitable. The first choice defers it for a while at the cost of greater pain and suffering some time in the future. It produces very high inflation, even hyperinflation. Ultimately markets collapse from the high inflation as people refuse to accept money in trade. Barter becomes a means of trade which dramatically decreases the possibilities and quantity of trade leading to a Depression.
The second choice produces a relatively quick Depression. Without the continued stimulus from government spending and Fed money-creation, the economy shrinks and debts are defaulted upon.
Gold will thrive under the first scenario. In a Depression, gold will likely not hold its nominal value because the purchasing power of the dollar will increase. It should hold its real value, however and will hold up better than most other assets.
In the first scenario, gold should outpace price increases as it becomes the safe-have choice. Jeff Clark
provides his reasoning:
… manias have occurred many times before
, but the main issue is that a mania in gold and gold stocks is the likely result of the absolute balloon in government debt, deficit spending, and money printing. Saying all that profligacy will go away without inflationary consequences seems naïve or foolish. Inflation may not attract investors to gold and silver as much as force them to it.
Ultimately the price of gold will recede once the Depression begins. Any super-profit will likely disappear during the Depression, although its purchasing power should be maintained.
Gold is money. It always has been. It increases in value as the purchasing power of fiat money decreases and decreases as fiat money increases in purchasing power. It is an alternative currency. When fiat currency deteriorates, real money appears to increase in value.
Like so many other things in our government-controlled economy, the price of gold is dictated by political actions more so than economic ones. If you believe that government will step aside and allow the economy to correct itself, then gold is probably not the place to be. If, on the other hand you believe government will continue to intervene in order to prolong the charade that a recovery is in place, then you probably expect gold to increase in value as Mr. Clark’s conditions will worsen.
A rare phenomenon has just occurred and may activate Fed action. The Fed and Mr. Bernanke are deathly afraid of deflation. Yet that is exactly what some data are suggesting. Zerohedge reports on a key indicator and the possible Fed reaction:
For the first time on record (based on Bloomberg’s data) 5-year / 5-year forward inflation expectations turned negative today. This kind of deflationary impulse has occurred twice in recent years and each time has been accompanied by dramatic Federal Reserve easing. The anticipation of the move by the Fed has caused Gold each time to surge higher on yet more expectations of the fiat-fiasco unwinding. Given the 5Y5Y inflation print currently, we would expect action from the Fed and one could argue that this would cause the price of Gold to rise to $2200 per ounce as the deleveraging continues.
The red arrows show the deflationary impulse (5Y5Y inflation is inverted) and the orange curve arrow shows the reaction function post Fed reaction to the blue arrow levels of the deflationary impulse.
A deflationary trend makes it harder to pay down debt or create jobs. Ultimately it produces a Depressionary scenario with massive unemployment and debt defaults. From an economists standpoint, that is inevitable at some point because the level of debt cannot be serviced. From a political standpoint, it is death. No political figure wants to be known as the new Herbert Hoover.
As mentioned many times before, decisions regarding the economy, or anything else for that matter, are not made in regard to what is best for the country. They are made for the benefit of the political class. The last thing the political class wants is a massive economic downturn. Hence, my guess is that the Fed will bend to the wishes of its political masters and “print money.”
As a side note, even if deflationary signals had not been seen, I would still expect government to print money simply because without it, government is unable to meet its obligations.