Gold And Hyperinflation

Jul. 3.12 | About: SPDR Gold (GLD)

The precious metals investing community tends to make a lot of generalizations about economics, debt, and 'fiat currencies,' few of which hold water when you look at them. While precious metals like gold (SPDR Gold Trust ETF: GLD) can definitely diversify a portfolio and provide returns during certain periods, they don't function the way everyone generally assumes they do. (See: Gold, The Worst Inflation Hedge Ever)

One of the statements I've seen floating around a lot is that the Fed's QE programs are the start of debt monetization, which will lead to runaway money printing that causes a hyperinflation cascade, etc. Commentators like Ron Paul often claim that the debt-to-GDP ratio of the US is approaching that experienced by Europe, and we'll go into a debt crisis, and everything but gold will become worthless. (Ron Paul: "we have a debt crisis in Europe and here. That's why we have to cut back.")

There are a lot of problems with that theory. First of all, unlike the countries in the EU, the US has complete control over its own currency—and consequently, the situations aren't at all the same.

Dr. Paul's comparison is based on a convertible currency system (which he is an advocate of), but it is 100% inapplicable to our non-convertible fiat monetary system. Comparing the federal government of the USA and the nations of the EMU is like comparing apples and oranges

A lot of this confusion centers around confusion on what the debt actually is. For a good primer, see Shaun Connell's article 3 Myths About The National Debt That Just Won't Die. It's dangerous for people to throw around buzzwords like "hyperinflation" because it causes the general public to change investing strategies based on something that just isn't true. Is the US at risk of hyperinflation? Not at all. From PragCap:

Hyperinflation is not merely high inflation or a collapse in confidence, but is actually due to severe exogenous shocks with very real and provable transmission mechanisms. Historically, these events tend to be:

  • Collapse in production.
  • Rampant government corruption.
  • Loss of a war.
  • Regime change or regime collapse.
  • Ceding of monetary sovereignty generally via a pegged currency or foreign denominated debt.

The US has none of these. As I've established before (Hook 'em Horns), the US economy isn't actually collapsing. While you could arguably call some government officials corrupt, "corruption" in the US is well below levels in third-world countries that have experienced hyperinflation. As for the currency, we're fiat—not pegged. And we don't issue foreign denominated debt. In fact, after a temporary period of deflation after the 2008 financial crisis and a small compensatory spike right after, we're returning to an inflation rate of just over 2%, which hardly classifies as hyperinflation.

It's important to note that gold prices are related more to fear of inflation than inflation itself. Because the "fear of inflation" has been high recently, gold prices have skyrocketed. But gold doesn't actually hedge against inflation—it hedges against the fear of inflation. From 1980 to 2000, the US experienced inflation that was, at a minimum, 3%/yr. Gold prices depreciated absolutely, and did even worse indexed to inflation.

If you're investing your life savings in gold bullion because you're expecting runaway hyperinflation, please stop. That strategy didn't work in 1980, when inflation rates topped 15%—and it's not going to work now.

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