Deflation fears persist and, with it, the impact it would have on the gold price. Many observers believe the gold price would go down. Let’s try to clarify things a little.

Though deflation sounds scary, it hasn’t always been the case. A general fall in prices is even a normal thing in a gold-backed system : The money in circulation being constant, prices of goods and services fall as they integrate productivity improvements (one’s money goes farther). Ron Paul reminds us that in the United States, from 1879 to 1900, prices have fallen by 47% while economic growth averaged close to 4% a year. Sound growth that we may never see again…

gold deflation

But deflation may also happen with a brutal contraction in asset prices. In such a scenario deflation happens after a bubble, and plunging prices are the signal of a grave crisis. So, which type of deflation do you think is threatening us? This one, of course.

There are so many bubbles today (stock market, and especially the sovereign bond market), and they’re being inflated by the central banks, as we often explain here. These will pop more or less brutally, one day, and it will bring a plunge in asset prices.

On the other hand, in the « real » economy in Japan, Europe and the States, what we see is not deflation, but disinflation, with almost stagnant prices, which reinforces the fear of real deflation. Mainly, the economy is in a thrombosis and there just is no recovery. All that money created by the central banks doesn’t reach the real economy; it stagnates (in bonds or as reserve), as can be seen in the money velocity which, in the United States, has reached its lowest level since the Second World War!

One must be aware that deflation is lethal for the highly-indebted one : his income becomes less, the value of his assets becomes less, so the real weight of his debt increases, bringing financial death. And today, there is way too much debt, whether sovereign or in the banking system. So deflation is clearly not an option for the central banks of Japan, the United States and Europe. They would rather risk hyperinflation… which, at least, would help in devaluating the debt!

Should such a mortal deflation scenario prompting the banks go all-in and to open the spigots to try to drive prices higher, one can only imagine where the gold price could go… Gold would then be the only available lifeline.

Philippe Herlin – Researcher in finance and junior lecturer at the Conservatoire National des Arts et Métiers in Paris / Contributor on Goldbroker.com

 

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