The Behavior of Gold Under Deflation

[Sapiens]

The Behavior of Gold Under Deflation

http://newsmine.org/dbsrv/cabal-elit...viorofGold.pdf

It is the deteriorating credit quality of currency issuers, not whether we operate under a fixed or floating exchange rate system, which is the key to understanding gold’s behavior under deflation.

23 page .pdf

[FRED]

Re: The Behavior of Gold Under Deflation

The Behavior of Gold Under Deflation

http://newsmine.org/dbsrv/cabal-elit...viorofGold.pdf



23 page .pdf

EJ writes in:

If we substitute the term "debt deflation" for the author's term "deflation" we have near agreement with the iTulip position, although some differences in how we arrive at similar conclusions.

The author's assertion that "It is the deteriorating credit quality of currency issuers, not whether we operate under a fixed or floating exchange rate system, which is the key to understanding gold’s behavior under deflation" is not supported by the evidence he presents.

Note from the author's graph the step function in the price of gold after FDR confiscates it and reprices it in 1933.

Just before that statement the author says, "Note that prior to 1968 nearly every time wholesale commodity prices fell (which indicated deflationary conditions), gold’s purchasing power rose. Since gold was linked to currency in a fixed ratio, as dollars purchased more and more goods in a falling price environment - so did gold."

Prior to 1971 under the international gold standard currencies inflated and deflated against gold but not each other. Since 1971 the purchasing power of gold rises and falls with the rise and fall of the purchasing power of currencies relative to each other.

Currencies rise and fall relative to each other since 1971 in response to the market's expectations of future economic strength and thus relative return on investment of assets priced in each currency, at least in the long term. In the short term relative currency values are also influenced by government interference in the currency markets.

Credit quality is at times a minor and at others a major factor in determining economic strength, so through a level of indirection the author is correct: gold's purchasing power in a currency rises and falls in relation to changes in credit quality insofar as credit quality strongly influences the markets perception of relative future economic performance. Changes in credit quality must, however, be significant and persistent in order to significantly influence long term economic performance. The markets made a determination in the summer of 2007 that a critical level of protracted credit quality deterioration had begun. Starting from then, after the gold price had remained nearly constant around $650 for a year prior, the dollar price of gold increased (dollars deflated against gold) to a greater extent than in euros as the markets anticipated both a falling return on investment in paper assets denominated in dollars and also the likely future response of the US government to debt deflation: to not intervene in the FX markets to support the dollar, to instead to allow a depreciating dollar to boost exports and thereby support the economy. In a world where relative economic performance determines currency values the logic is sound. If the government intervened in the currency markets to support the dollar in 2007 US exports would not have surged and the markets would have devalued the dollar as in anticipation of the US economy weakening even more than it did, unsupported by rising exports. Best case government intervention in the dollar would have been zero sum.

From here the game plays out as a complex interaction of deteriorating credit quality among nations around the world with Europe apparently more vulnerable than the US, structural factors within and among trade blocks influencing relative economic strength and determining currency values, and unknowable political and philosophical factors determining the monetary policy response. My take on the Fed these days is that they are surprised by events and that there is not strategy beyond living to fight another day, which is historically how every government stumbles into hyperinflation that has experienced one.

One thing is apparent: in a debt deflation no nation can risk launching a deflation spiral by permitting its currency to strengthen appreciably against others. Pre-1971 the risk was that a nation's currency strengthened too much against gold. Today, ultimately relative credit risk will determine relative currency values.