Is holding cash very risky?

December 11th, 2007

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One of the myths that is often perpetuated in the mainstream world of finance and economics is that holding cash is considered ‘conservative.’ This is one of the myths that we wish to debunk today. In fact, in this current climate of world economic order, holding cash is very RISKY!

If this is the first time you are reading this, you may be completely surprised by this assertion because it completely goes against the grain of conventional wisdom. Therefore, what follows will only make sense if you first understand the fundamental reason for holding gold- read Why should you invest in gold? first before proceeding if you are unfamiliar with this topic.

As you have read the news recently, the current economic threat facing the US economy right now is deflation. Deflation, according to the Austrian School of economic thought, is defined as the contraction of money and credit. Conversely, inflation is defined as the expansion of money and credit. The popular mainstream notion of deflation, which is defined as falling of general price levels, is wrong and misleading. Thus, this is the most important concept that you have to get right before proceeding further- see Cause of inflation: Shanghai bubble case study.

Now, back to deflation in the US. Property prices is falling. The credit crunch is resulting in the rapid drying up of liquidity. Big financial institutions are facing massive asset write-downs (in terms of billions of dollars) due to the infamous sub-prime debacle. All these are merely symptoms of deflation (see Spectre of deflation). As we said before in Inflation or deflation first?,

Now, faced with the threat of a deflationary recession, what can the Fed do? Politically, it is impossible for them to allow a recession run its full course in order to clean up the prior excesses of the bubble. They will do anything and everything to ?prevent? another recession. The only way for them to do that is to do what they always did?pump even more liquidity into the economy (a.k.a ?print? money).

It is monetary inflation that causes the build up of mountainous bad debts and structural damage (through mal-investments) to the US economy. The inevitable monetary deflation that is running its course right now is threatening to tip the economy into an acute recession (perhaps even a depression). There is a sense of urgency in the Fed to ‘prevent’ a recession by propping up the solvency of the economy. The only way to do that is through monetary inflation (‘print’ money) i.e. ‘print’ its way out of unpayable amount of colossal debt. Each additional dollar that is ‘printed’ will degrade the quality of the US currency. The symptom of such currency degradation is price inflation.

The rest of the world is not off the hook either. As we said before in How does the US export inflation?, as the US debase their currency, other nations have to follow suit. Thus, every national currencies are in a race to the bottom.

So, can you see why holding cash is risky? The current world economic order is setting itself to a path of synchronized currencies depreciation. The purchasing power of cash will fall and continue to fall i.e. price inflation will rise and continue to rise. Your superannuation, pension and retirement fund may grow in nominal terms, but in the end, the risk of losing significant value through price inflation is high.

The signs are there: synchronized cutting of interest rates (‘print’ money), bail-outs, more cutting of interest rates, more bail-outs, rescue packages, bank deposit guarantee (remember Northern Rock?), e.t.c. All these things (monetary inflation) are happening in the midst of price inflation.

We have said it before many times, and we are going to repeat ourselves again: the only way to protect yourself against currency debasements is to accumulate gold, which has a history of functioning as money stretching back to early human civilization.