In response to our previous article (What will happen if RBA cuts to zero?), one of our readers asked,
Hi, This article concludes with a disturbing scenario. Asset price deflation with consumer price inflation. Gold is as asset class, how will it fare in this scenario? It seems that gold is starting its transition back to being money, what would it take for that transition to happen, do you think its under way or likely?
Firstly, for those who are new to this publication, we would first refer you to this guide, Why should you invest in gold?. It contains quite a number of useful articles for you to understand gold. We recommend you to read them first.
Now, back to our reader’s questions. The first one is, how will gold fare in times of debt deflation, foreign capital flight and price inflation? Let us go through each asset class one by one:
- Property is definitely a loser because it is highly geared asset class. Since business and personal solvencies will be threatened en masse in a debt deflation, highly geared assets will be falling rapidly in prices. Rising price inflation of inelastic non-discretionary goods will worsen the solvency situation of many.
- Stocks are unlikely to well in a sick economy.
- The same goes for debt securities.
- Assuming that more and more foreigners are holding Commonwealth Government bonds (thanks to the growing budget deficit from the bigger and bigger ‘stimulus’ packages), they will become increasingly nervous of the falling Aussie dollar. Thus, a sell-off in government bonds cannot be ruled out. This implies foreigners’ fear of sovereign debt default.
- As foreign capital flees Australia (due to the deteriorating economic situation), a banking crisis cannot be ruled out. It’s one thing for the government to guarantee bank deposits but another to actually implement the guarantee. How much can cash at bank be trusted? Perhaps the government will ‘guarantee’ bank deposits and at the same time, put in capital controls (e.g. restrict foreign capital from fleeing, limit the amount of cash that can be withdrawn, etc)?
As you can see, this disturbing scenario is one in which there are no textbooks to refer to. The government will be making rapid-fire decisions in real-time. Thus, all our projections here are guesstimates and speculations. But one thing is certain: uncertainty and unpredictability will rule the day. As a result, physical gold (and silver) is the only asset class that can give you a sense of security. In such a day, the nominal price of gold is irrelevant.
Next, our reader asked: Is gold starting its transition back to being money?
We do not know the answer to this question. But we are sure the government will be hell-bent in preventing it from happening as long as it remains strong. The qualifier in bold is a very important one that you should take note. Hitler once said that the gold standard is not needed because the state will be so strong that such a standard is unnecessary (we do not know whether this is true or not, but history buffs may want to dig out the reference for that). Also, Marco Polo was astounded that the authority of the Khan could turn paper into something that was as good as gold and silver, on pain of death. In the US in the 1930s, gold ownership became illegal. Hence, a strong government is anti-thesis to gold being money. Conversely, if the government is weak, gold stands a much better chance of functioning as money.
Tags: Commonwealth Bonds, debt deflation, Gold, Hitler, inflation, Khan, Marco Polo, Silver
