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Black
Swans, Yellow Gold
by Michael J. Kosares
(The following is
the first of a five part series on how gold performs during periods of
deflation, chronic disinflation, runaway stagflation and hyperinflation. The
first installment examines gold’s safe-haven role during a deflationary
event like the global 1930s economic depression.)
“The inability
to predict outliers implies the inability to predict the course of history. . .But we act as though we are able to predict
historical events, or, even worse, as if we are able to change the course of
history. We produce thirty-year projections of social security deficits and
oil prices without realizing that we cannot even predict these for next
summer — our cumulative prediction errors for political and economic
events are so monstrous that every time I look at the empirical record I have
to pinch myself to verify that I am not dreaming. What is surprising is not
the magnitude of our forecast errors, but our absence of awareness of
it.”
- Nicholas Taleb, The Black Swan — The Impact of the Highly
Improbable, 2010
“Having been
mugged too often by reality, forecasters now express less confidence about
our abilities to look beyond the immediate horizon. We will forever need to
reach beyond our equations to apply economic judgment. Forecasters may never
approach the fantasy success of the Oracle of Delphi or Nostradamus, but we
can surely improve on the discouraging performance of the past.”
- Alan Greenspan,
The Map and the Territory,
2013
Introduction
This short study
examines gold’s performance under the four most commonly predicted
worst-case economic scenarios — a 1930s-style deflation, chronic
Japanese-style disinflation, a 1970s-style runaway stagflation, and a
Weimar-style hyperinflation. “That men do not learn very much from the
lessons of history,” Aldous Huxley once wrote, “is the most
important of all the lessons of history.” Though I agree with
Huxley’s assessment when applied to contemporary policymakers and
central bankers, I do not agree with it when applied to their counterparts in
the private sector, i.e., the individual investors. As justification, I offer
the ongoing (and long-term) success of the USAGOLD website as well as the
soaring statistics of late on private gold ownership both here and abroad,
most of which has been accumulated for safe-haven purposes. Individually, we
can and do learn the lessons of history even if we do not always do so
collectively.
Black Swans, Yellow
Gold is dedicated to those who believe, like Nicholas Taleb,
that it is just as important to prepare for what we cannot foresee as what we can. Some might put their
money on the latest Oracle of Delphi or the contemporary reincarnation of
Nostradamus — or even an all-seeing eye plug-in that can be downloaded
from the internet — but in the end, such notions are the dreams of government
planners and retired central bankers. For the rest of us, a solid hedge in
gold coins, as your are about to read, is the more
sensible and reliable alternative — a wealth haven for all seasons.
We invite you to
return to these pages periodically for the second installment in this series
which we plan to publish next week.
Gold
as a deflation hedge (United States, 1929)
WEBSTER DEFINES
DEFLATION AS A “CONTRACTION IN THE VOLUME of available money and credit
that results in a general decline in prices.” Typically deflations
occur in gold standard economies when the state is deprived of its ability to
conduct bailouts, run deficits and print money. Characterized by high
unemployment, bankruptcies, government austerity measures and bank runs, a
deflationary economic environment is usually accompanied by a stock and bond
market collapse and general financial panic — an altogether unpleasant
set of circumstances.
The Great Depression
of the 1930s serves as a workable example of the degree to which gold
protects its owners under deflationary circumstances. First, because the
price of gold was fixed at $20.67 per ounce, it gained purchasing power as
the general price level fell. In 1933, when the U.S. government raised the
price of gold to $35 per ounce in an effort to reflate the economy through a
formal devaluation of the dollar, gold gained even more purchasing power.
President Franklin D. Roosevelt also confiscated gold bullion by executive
order in concert with the devaluation, but exempted “rare and
unusual” gold coins which later were defined by regulation simply as
items minted before 1933. As a result, only those citizens who owned gold
coins dated before 1933 were able to reap the benefit of the higher fixed
prices. The accompanying graph illustrates those gains, and the gap between
consumer prices and the gold price.
Gold as a deflation hedge
Second, since gold
acts as a stand-alone asset that is not another’s liability, it played
an effective store of value function prior to 1933 for those who either
converted a portion of their capital to gold bullion or withdrew their
savings from the banking system in the form of gold coins before the crisis
struck. Those who did not have gold as part of their savings plan found
themselves at the mercy of events when the stock market crashed and the banks
closed their doors (many of which had already been bankrupted).
How gold might react
in a deflation under today’s fiat money system is a more complicated
scenario. Even one under a fiat money system, the general price level would
be falling by definition. Economists who make the deflationary argument
within the context of a fiat money economy usually use the analogy of the
central bank “pushing on a string.” It wants to inflate, but no
matter how hard it tries the public refuses to borrow and spend. (If this all
sounds familiar, it should. This is precisely the situation in which the
Federal Reserve finds itself today.) In the end, so goes the deflationist
argument, the central bank fails in its efforts and the economy rolls over
from recession to a full-blown deflationary depression.
How the government
treats gold under a deflationary scenario will play heavily into its
performance:
- If gold is subjected to price controls and restricted ownership, as it
was in the 1930s deflation, it would likely perform as it did then, i.e., its
purchasing power would increase as the price level fell.
Under such circumstances, the ownership of “rare and unusual”
gold coins might once again come into play.
- If ownership is
not restricted, it would turn out to be the best of all possible worlds for
gold owners. Its purchasing power would increase as the price level fell, and
the price itself could rise as a result of increased demand from investors
hedging systemic risks and financial market instability.
Note: That, by the
way, is the primary reason governments tend to restrict gold ownership when
confronted with widespread bank runs and failing financial markets.
Governments seize gold not because they need the money; they seize it to cut
off the escape route and force capital flows back into banks and financial
markets. As an aside, that is precisely the reason why governments have an
interest in controlling the price of gold. Former Fed chairman Paul Volcker,
it has been copiously reported, once said, “Gold is my enemy. I’m
always watching what it is doing.” Though there is no direct evidence I
know of that the Fed or Treasury Department intervened directly in the gold
market during Mr. Volcker’s tenure, his statement does reflect the
acute interest in gold on the part of monetary policy-makers. Alan Greenspan
voiced a similar interest in gold throughout his Fed chairmanship and still
does today, though unlike Volcker he has always defended gold and expressed
an appreciation for its use as a form of money or final payment or
reconciliation. Gold, in the end, is not just competition for the dollar; it
is competition for bank deposits, stocks and bonds most particularly during
times of economic stress, and that is the source of enduring interest among
policy-makers.
If
you are looking for a gold-based analysis of the financial markets and
economy, we invite you to subscribe to our FREE
newsletter – USAGOLD’s
Review & Outlook, edited by Michael J. Kosares, the author of the preceding post, the founder of
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