Gold Is Bad in a Deflationary Environment—Another Gold Myth


". . .gold is surely a currency of highest quality and should therefore outperform the market."

The development of gold in a deeply deflationary environment has not been subjected to much analysis. The only relevant period that would lend itself to comparison is the Great Depression of the 1930s. However, those were the times of the gold standard (i.e., the gold price was fixed).

By 1934 the industrial production had fallen by 50%, and the unemployment rate was up at 30%. Governments around the world had to step up their spending drastically and stop the price slump. The Western currencies were gradually depreciating. However, the economic situation in the U.S. in the 1930s could not be compared to the current scenario. Whereas the country used to be the big creditor nation, it has now turned into the single biggest debtor.

We can try to establish how the gold price would have developed by analyzing the subsequent depreciation of the currencies after abandoning the gold standard. Great Britain depreciated the pound in September 1931 by 52%, and the U.S. followed by appreciating gold by about 60% in 1933.

Enormous buying pressure had been building up during the period of the gold standard. When gold reserves had fallen to the minimum requirements in '33, President Roosevelt instructed that all private gold holdings be confiscated. All gold exports were discontinued, and the dollar depreciated massively against gold.

Gold shares, on the other hand, were going from strength to strength. The stability of the gold shares during the general crash was likely due to the gold price being fixed, thus stabilizing the revenues of the producers.

Seeing that in periods of deflation, cash outperforms all other asset classes, this should also apply to gold. Especially in an environment of expansive central bank policy, gold is surely a currency of highest quality and should therefore outperform the market. This means that gold seems to be an excellent investment also in times of deflation.

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