There Is No Hedge Against Inflation

You’ve seen him: an older man sitting next to a roaring fire or maybe  walking the grounds of his ranch or he might be  in a suit facing the camera. The messages are all the same: something about  “troubling times” and “safety and security” —maybe they mention the  federal reserve or money printing. Times are bad and could get worse, but  they can help you. They have the answer. What is this company selling? GOLD.

Why would you want a gold coin or bar? It doesn’t earn interest and it  doesn’t grow or produce anything. It is vulnerable to theft. The price can  move down with astonishing speed as we saw last April (as of the time of this writing it has retraced over 50% of that selloff). But could it go up in value, could it “skyrocket” as the gold shills say?

Keep in mind that gold has already gone up a lot recently, about  fivefold  in the past ten years. And to simply say that gold is a hedge against inflation is misleading. If you compare the price today, let’s say $1500 per oz, to the average price in 1974, about $150/oz, it actually exceeded  inflation. Using CPI over this period gold’s value increased at about double  the rate of inflation. However, if you bought gold in 1980, average price that year about $600/oz, you’d have to wait until 2006 for the price to come back to that level and not inflation adjusted dollars either (inflation destroyed about 65% of the purchasing power in that timeframe – and this is using CPI which notoriously understates real world prices). Gold prices and inflation are not as closely correlated as the gold sellers would have  you think.

But what about “these troubling times”? It’s different now, right? It might be. This is basically what they’re talking about: the federal government and the federal reserve have been acting in tandem to recapitalize the U.S. economy after the 2008 crisis. The government has been spending like crazy and running huge deficits (and buying lots of votes, funny how that  works out for them). These deficits are financed by the issuing of bonds of which the federal reserve bank has been the main buyer under the guise of  Quantitative Easing  and the Zero Interest Rate Policy. This what they mean by printing money –  the fed can buy whatever it wants and it has been buying these bonds that are loans to the government.

The Fed doesn’t need money, rather, it creates it. It is the central bank and it can just put the bonds on its balance sheet. A lot of people, this author  included, think the government and the Fed are nuts to think that this course would enable economic growth and it will probably only lead to  inflation which could become severe and maybe uncontrollable. Without turning this into a financial doomer article, let’s just say both sides make their case and we won’t know which one is right until this QE and ZIRP experiment is over.

This is what it comes down to: if the price of gold in dollars goes exponential in a hyperinflationary situation everything else  priced in dollars is going to do the same. You can’t expect that your gold coin will buy the same goods that it would buy now if this happens. The actual purchasing power of your gold will surely decline as day-to-day essentials  become prioritized. Put another way, if 1500 this week buys you one gold coin or 250 basic meals, in a hyperinflationary situation that gold coin might exchange for the equivalent of 100 meals or maybe not even twenty. Of course, 1500 in a bank account or your mattress would be worth much less – maybe not even one meal. The possible hyperinflation scenario is the most compelling reason to hold gold now. It’s not about getting rich. It’s about retaining some savings in the face of a massive financial collapse.

In reality, nothing keeps up with inflation like you will want. Agriculture futures are seasonal and your position has to be rolled over every so often costing you fees and changing your cost basis. Your  inflation hedge could get destroyed by a good harvest or weak global demand.  Stocks are typically seen as an inflation hedge but in a real collapse your brokerage company or even your local bank might not even exist anymore. You may eventually be made whole on the companies you own but this will take years.

Outside of a financial crisis the case for gold is weak. If you’re holding gold the best case scenario is unclear. Perhaps the price rises faster than inflation but that’s probably a longshot. Consider that if  interest rates start to rise, if the Fed sees the light on the harm ZIRP is doing, and if inflation is mild then those holding gold are going to be screwed as many decide to sell, preferring actual cash. Expect gold to lose at least 30% from today’s prices and it could happen in a day or two. Don’t  expect your dealer to give you a good price or even answer your call or email if everyone comes in selling.

The risk of gold losing value in the face of an improving economy is something you need to be aware of and in a crisis it won’t provide the kind  of financial safety that the gold bugs allege. If you still need a place to park your savings you might consider silver. It’s incrementally cheaper to get into and has more industrial value than gold though it is historically more volatile. Or what about booze? A case of good whiskey or rum is highly barterable, doesn’t spoil, tracks inflation as well as anything, and if times get better (or worse), you can always drink it.

Read More: The Ascent Of Money