The hilarious thing about deflation
- Deflation or inflation?
- Are precious metals good deflationary investments?
- It's counter intuitive, but...
I've flirted with the idea of dedicating each Friday's edition of the Resource Prospector to more humorous topics. But it's tough to be appropriately reverent about something as serious as our money while at the same time being humorous.
And to be honest, not many of the current topics in the resource sector are especially hilarious.
For instance: there's currently some degree of argument over whether we're currently experiencing inflation or deflation. I can't think of a more non-funny topic. If they say that comedy = tragedy + time, or that comedy is tragedy that happens to someone else, then it doesn't seem like there's much opportunity for jokes. After all, deflation or inflation is happening to all of us all of the time, so no matter how tragic it is now, it's likely to be at least as tragic later.
Oh well, maybe I'll find something appropriately funny for next week. In the meantime, if you have any good jokes based on economics, investing or politics, feel free to send them my way: editorial@resourceprospector.com
On the topic of inflation vs. deflation:
I haven't seen prices drop - and according to the Bureau of Labor and Statistics' own Consumer Price Index, prices across the board for 2010 have been flat to slightly higher through June 30th.
Another measure of inflation/deflation is the velocity of money - measured most broadly as the Federal Reserve's M1 Money multiplier:
This chart shows the speed at which money flows through the economy - and right now, money simply isn't flowing from the Fed through banks and into the marketplace. That's a deflationary signal.
I firmly believe that the Fed is in a suicide pact to
prevent deflation which will eventually result in epic inflation - but until
then, we'll likely see some mild deflation.
But let's assume the worst case scenario - that I'm completely wrong, and that we're in for many long years of deflation, not inflation, and prices will fall, not rise. Maybe Ben Bernanke re-writes his dissertation on the topic and does a 180. Maybe he lands the helicopter and starts sweeping dollars back into the Fed's coffers.
How will silver and gold hold up? If these two precious metals skyrocket during periods of high inflation - it would simply stand to reason that they might catastrophically plummet during periods of deflation. Right?
Well, fortunately for gold and silver investors, economics is not a simple if-then Boolean logic problem.
According to a recent study from JP Morgan (NYSE: JPM) gold and silver both outperformed the broad market during the Great Depression, one of the worst deflationary periods in US history:
Here's the relevant quote from the JP Morgan report:
"The performance of silver gives us confidence that precious metals are likely to outperform the general markets in a downturn. In a really tough deflation, the absolute price levels of the metals could weaken, even as they outperform most other sectors."
I found another, older paper written by Sam Hewitt, a Ph.D and Certified Financial Advisor. He wrote the paper in 1996 for a firm called Sun Valley Gold Company - so it's best to take his findings with a grain of salt, but I found the paper to be useful in answering why gold and silver might outperform during a period of deflation, when you'd expect the opposite.
He says,
"In historic US deflations, individuals had the choice between paper currency or gold as hoarding vehicles. The historical record demonstrates that loss of confidence in the issuer of paper currency is often a sufficient reason for individuals to choose gold over paper currency."
So, it's precisely because people lose faith in currency during deflation that gold and silver rise - or at least don't fall as much as other assets.
The problem with deflation, I'm sure Ben Bernanke would tell you, is that people hoard capital, which has a chilling effect on growth, wages and eventually prices. And when people think of hoarding, they tend to think of gold and silver as good places to hoard capital.
It's counter-intuitive. You'd expect prices of gold and silver to fall, just like prices of every other asset. But it's not the case.
So, even though I'm "hoarding" gold and silver anyway because I fear inflation, it's good to know it will hold up even if I'm completely wrong and that deflation is coming down the pike.
Have a great weekend,
Kevin McElroy
Editor
Resource Prospector
