Gold News

Inflation and the Gold Price

How Buying Gold could protect you from Bernanke's success...

HOW IS IT at all possible for a real recovery to take root in the hard, barren soil of falling house prices and slipping consumer earnings? asks Bill Bonner in the Daily Reckoning.

But if the economy is not improving...then there should be no increase in inflation...and no pressure on the Gold Price, right?

Maybe investors don't anticipate a recovery at all. Maybe they're Buying Gold because they see the economy getting worse, not better. We associate a rise in the Gold Price with inflation. But gold is much more versatile than we think. It protects your wealth when paper money loses its value. It also protects your wealth when paper money gains in value. It protects you when you are right...and when you are wrong.

How so?

During the Great Depression, for example, the price of gold rose...against Dollars...even though the prices of food, clothing and other consumer well as the prices of investment assets...were falling in Dollar terms. Why? Because money gains value — relative to things — in a depression. Gold is money. It is the best money. It is the only money that has stood the test of time.

Besides, there is more going on. In a financial crisis...or a depression...investors begin to doubt that their counterparties will make good. Banks fail. Investors go broke. You own a mortgage, and then you discover that the homeowner has left town...and the house has lost half its value. You own a note, and then you discover than the payer is bankrupt; your note is worthless. You own shares in a company; and then the company goes out of business.

When you are in a de-leveraging phase, you discover that many of the assets of the previous credit bubble are not assets at all. And while you're waiting to find out, the best thing to have in your safe is gold.

As uncertainty rises; so does the Gold Price.

The price of gold also rises when the return on other assets declines. At 1.82%, the real return on a 10-year T-note is negative. Consumer prices are rising faster. So, the reward for lending to the government is less than zero.

Normally, holding gold costs you money. You give up the return you could get from 'risk free' investments (Treasury debt). Now, you give up the risk from reward-free investments.

Gold goes nowhere. It produces no yield. It pays no dividends. It makes no profits. You can't live in it. You can't drive it. You can't hang it on your wall and admire it.

But when the return on Treasury debt is negative, what do you give up by owning gold? You give up a loss!

You also give up the risk of a much bigger loss. The Fed is bound and determined to bring up the inflation rate. Ben Bernanke has suggested that he might set the inflation target higher than 2%. He has announced that he will keep the Fed's key lending rate near zero for the next 3 years. He has hinted that he is ready to print more money — QE3 — if conditions warrant.

Holding gold protects you from Bernanke's success. For if he succeeds in raising the rate of inflation, gold will surely soar. And there is substantial risk — bordering on certainty — that he will be no better at creating moderately more inflation than he has been at creating moderately more GDP growth.

It is quite possible that he will overshoot.

Normally, inflation is a feature of the banking system. The system takes the Fed's monetary grubstake and parleys it into the nation's money supply. Banks magnify the money supply by lending...and thereby create more demand, which raises prices. They do this by making people who then spend the money.

This sort of inflation is controllable, by raising interest rates and tightening banking credit rules. But there's another form of inflation. The kind that starts with an "h."

Hyperinflation happens when the banking system breaks down. People lose faith in the money itself...and the people who control it. Foreign Dollar holders may worry that the Fed is printing too much money. It may even be good economic news that causes them distress; they may anticipate higher inflation rates, and a sell-off of the Dollar, which would lower the value of their Dollar reserves. They may figure that they are better off diversifying into Yuan...or gold.

Then, when other investors and householders see the Dollar falling...they get panicky too. Pretty soon, people are digging around in drawers, bank accounts and mattresses...looking for Dollars — just so they can get rid of them.

That is when Dollars hit the hyperinflationary fan. Our old friend Michael Checkan tells what it was like in Argentina in the late '80s:

"Imagine a $2.00 gallon of milk spiking to $775.40 within a year — like in Argentina, 1988."

Thinking of Buying Gold?...

New York Times best-selling finance author Bill Bonner founded The Agora, a worldwide community for private researchers and publishers, in 1979. Financial analysts within the group exposed and predicted some of the world's biggest shifts since, starting with the fall of the Soviet Union back in the late 1980s, to the collapse of the Dot Com (2000) and then mortgage finance (2008) bubbles, and the election of President Trump (2016). Sharing his personal thoughts and opinions each day from 1999 in the globally successful Daily Reckoning and then his Diary of a Rogue Economist, Bonner now makes his views and ideas available alongside analysis from a small hand-picked team of specialists through Bonner Private Research.

See full archive of Bill Bonner articles

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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