World's premier investment when a major boom becomes a major bust
[Editor’s note: Below is an excerpt from a commentary originally posted at www.speculative-investor.com on May 17.]
The actions of the U.S. Fed and Treasury between September and December of last year prompted fear in some quarters that the U.S. was speeding towards a Zimbabwe-style hyperinflation. However, while we view hyperinflation as inevitable over the very long-term, at no stage have we viewed it as a serious intermediate-term threat. In our opinion, the probability of the U.S. experiencing hyperinflation within the next two years is close to zero.
We therefore don't believe that the threat of hyperinflation is a good reason to invest in gold today. We also don't think that the potential re-emergence, within the next 12 months, of what is commonly called "price inflation" is a particularly good reason to invest in gold at this time, although the prices of everyday goods and services probably will begin to rise in 2010.
To understand why we expect gold-related investments to do extremely well over the next few years it must first be understood that gold has never performed especially well (on a relative basis) during inflation-fuelled booms and has always performed very well during the busts that follow inflation-fuelled booms. Bob Hoye has done some good work on this topic covering hundreds of years, but we don't need to go back very far to see the pattern. Analysis of the past decade's market action will reveal that gold was a top performer during the mini bust of 2000-2002, generally lagged industrial commodities such as oil and copper during the major worldwide boom of 2003-2007, and then became the world's premier investment once the major boom transformed into a major bust. Looking at just the first half of this year we can see that gold started to weaken after hope of economic recovery -- the "green shoots" that everyone is talking about -- began to grow within the financial world. It is reasonable to expect, based on both history and logic, that the investment demand for gold will resume its upward march after this hope is dashed.
Now, just because gold has historically been a good investment during economic busts does not mean that it would be a good investment under the current monetary system if genuine deflation (a sustained contraction in the supply of money) were to occur. In fact, we strongly believe that gold would perform poorly if the government and the central bank stayed out of the way and let the money supply and prices collapse to their natural levels.
The way we see it, gold has been doing well and should continue to do well because of what governments are doing to PREVENT the natural flow of events from occurring. Whether officialdom is successful or not in propping up prices by creating new money and by transferring obligations from the private to the public sector is not the most important issue as far as an investment in gold is concerned. The most important considerations are that desperate attempts are being made, and will continue to be made, to divert the economy from its natural course, and that these attempts will cause additional economic problems and prolong the agony. This, and not the ultra-low-probability risk of hyperinflation or the relatively minor (at this stage) threat of so-called "price inflation", is the best reason to be bullish on gold at this time.
Although it doesn't mention gold, an article recently posted by Hans-Hermann Hoppe at https://mises.org/story/3449 touches on the main reason why gold should do extremely well over the years ahead if policymakers continue along their current path. The article explains that a general increase in the demand for cash is a rational response to increased uncertainty. The current situation, for example, is that people want to hold a lot more cash than they did two years ago because from their perspective the future is less certain today than it was back then. Moreover, the article explains that the hoarding of cash serves a useful economy-wide purpose in that it leads to a reduction in the general level of uncertainty and thus paves the way for a sustained recovery to begin.
Unfortunately, due to the fundamentally flawed thinking that dominates the halls of political power, the general desire of people to add to their cash holdings is wrongly interpreted as something that must be fought against. Policymakers therefore attempt to dissuade the public from increasing its cash savings, and they do so by implementing various schemes designed to devalue cash and prop-up prices. But this causes uncertainty to remain at a high level, ensuring that the desire to save remains strong, and at the same time creates the incentive to save in terms of something other than the official currency. After all, governments and their central banks are effectively saying: "If you increase your savings in terms of our currency, we will punish you!" Consequently, people are driven to save in terms of a highly liquid money-like substance that cannot be depreciated by the government.
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