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I always assumed that physical gold is inflation-proof, but my advisor at my bank claimed it is not — unfortunately without going into details. Now I wonder what he meant.

My assumption was: If I buy gold now for $100 and that inflation reduces the value of the Dollar by 50%, I will be able to sell my gold for $200. The $200 are worth the same as my $100 before deflation.

Conclusion: Gold is inflation-proof. But by this simple logic every physical entity that does not lose intrinsic value over time is inflation-proof. Am I wrong here or is it really that simple?

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    There is a flaw in your assumption: There no guarantee that the price rise of gold will exactly compensate rise inflation. It may well be (significantly) less than what you expect. – check123 Oct 17 '11 at 5:51
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  • I'm really dumb with this sort of thing, but one property of gold is that it will always be gold. Investing in currency or pork bellies or Amazon all run the risk of someday being non existent. Not just their trade value, but potentially the product itself. Gold could some day be seen as worthless, but it will still be gold. So if it became valuable again later, your gold will have value again. It doesn't have intrinsic value, but it has intrinsic state. – Anthony Jan 10 at 3:51
36

As I argued in the comment to your question, your assumption is flawed. Here are some facts that counter your assumption (link to resource):

  • Fact #1: Gold went from $105 in 1976 to $850 in January, 1980. Consumer prices increased by about 28%. Verify this here.
  • Fact #2: Gold went from $850 in 1980 to $256 in 2001. Consumer prices more than doubled.
  • Fact #3: Gold went from $256 in 2001 to $1,011 in March, 2008. Consumer prices went up about 20%.

This is also pretty good article on Comparing correlation between Gold and Inflation.

12

Ye, you're wrong. A blanked statement that "gold is inflation proof" doesn't stack up historically - one can pick various pairs of points in time to show gold rising as prices rise; or gold falling as prices rise. And periods of deflation are, happily, sufficiently rare to be able to draw any meaningful conclusions either way.

As Willem Buiter explained in the Financial Times, gold is a fiat commodity: its price is almost entirely driven by speculative demand and supply, through traded instruments. Its industrial and vanity uses form a very small proportion of demand. Hence "fiat" - its price is determined by people perceiving and trusting it has value; rather than by its utility. Its intrinsic value (to the extent that "intrinsic value" ever exists) is very very low. Its market price exists purely because of a common superstition about it being a store of value.

As such, there's no reason why its price should vary inversely with a dollar inflation index: the dollar inflation index will reflect changes in a basket of consumer goods, which will have virtually nothing to do with gold.

Similarly, as a good in its own right, it will experience inflation: during the last few years, it's experienced significant price rises, after the introduction of a group of ETFs swelled speculative demand.

  • I think alot of experts fail to distinguish between gold etfs and physical gold. I disagree with the author but I have removed the downvote as at least the claim is sourced. – user4127 Oct 17 '11 at 10:28
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    The term "fiat commodity" is probably intended to be tongue-in-cheek. Just to be clear, the definition of "fiat" implies an authoritative source of value (merriam-webster.com/dictionary/fiat). Gold is not "fiat" because there is no single government that controls its issue or has declared it legal tender. (Gold coins may be legal tender in some places, but that is distinct from bullion.) – Mark E. Haase Oct 18 '11 at 20:12
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    Well that's kind of rude, because I do have a clue. I provided a decent citation (a well known dictionary) and it includes several meanings, none of which cover the manner in which you have used it. Your link to a blog post is interesting but it hardly redefines the term "fiat". – Mark E. Haase Oct 18 '11 at 20:52
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    Actually it says, "Chiefly literary any command, decision, or act of will that brings something about". "Chiefly literary" is an important qualifier. Perhaps if this was prose.stackexhchange.com, I would be more sympathetic, but I sincerely believe you are confusing the issue by using the term fiat in a manner that is directly contrary to the mainstream definition as applied in the area of political economy. But I'm not going to argue any further. – Mark E. Haase Oct 18 '11 at 21:02
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    @mehaase Ummm, gold coins that are without numismatic value ARE bullion. You don't claim otherwise, but I just wanted to mention that. – Ellie Kesselman Nov 17 '11 at 21:16
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I doubt I can speak for the banker, however, as was discussed long ago by Adam Smith, gold, as with any other commodity, may lose its value for many reasons, one simple one being the increased mining as was historically the case when finding new very rich mines of gold, increasing its supply. It may also lose value if some types of regulation or taxation are put on it.

So to that effect, if you consider gold to be money, then gold is not inflation proof.

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    Adam Smith's discussion of gold is worth reading. It notes that wealth might be more truly measured in cattle than in gold. – Paul Dexter Oct 15 '11 at 22:18
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    One of these decades Planetary Resources or some successor is going to drag an asteroid full of gold to Earth, and the price of gold will plummet, and all the "gold will never go down!" people will cry. :) – user296 May 2 '12 at 18:22
  • Ha, @fennec - it's nearly a year later, and I just wrote about that very thing - joetaxpayer.com/nasas-golden-opportunity – JoeTaxpayer Apr 15 '13 at 2:46
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Well, inflation is a tricky word. Let me break this question into two pieces:

My assumption was: If I buy gold now for $100 and inflation reduces the value of the Dollar by 50% …

Reduces the value of the dollar relative to what? Keep in mind that we can only measure the value of a dollar in terms of what it might exchange for, whether that is goods, services, or other monies. So if prices are rising but exchange rates are constant, some might say the value of the dollar is declining while others might say the value is holding steady. It's a matter of definition.

… I will be able to sell my gold for $200. The $200 are worth the same as my $100 before deflation.

Specifically, you may be asking, "If the dollar falls 50% against gold, then my gold doubles in value, right?"

Again, this goes back to the question I prompted above: gold doubles in value relative to what? If gold only doubles in value relative to the dollar but has no increased buying power for ordinary goods and services, then it's not much good to you.

If gold doubles in value relative to the USD and all of the goods and services you typically buy, then your purchasing power has effectively doubled.

What actually happens during inflation and deflation is somewhere between the two extremes, since as others have pointed out:

  1. The supply of gold does increase over time (as more is mined).
  2. The supply of USD also changes over time (generally increasing).
  3. The demand for gold, USD, goods, and services all fluctuate over time.
2

No, gold is not inflation-proof. Everything that can be used in a transaction is subject to supply and demand. This is true for currency as well: "Monetary inflation is a sustained increase in the money supply of a country."

Inflation means an increase in supply of an exchange commodity i.e. the worth of all objects in relation to that commodity increase - their value is inflated in comparison.

All objects (real or not) can be transacted and are therefore subject to inflation/deflation. A good example of this is a purchased copyright, where you are purchasing someone's imaginings (it doesn't even exist in reality).

As a side note, nothing (not even gold) has intrinsic worth.

  • Note that what you quoted is the definition of monetary inflation. When people talk about inflation, they generally mean price inflation. If the money supply keeps pace with an increasing GDP, there will be monetary inflation, but prices will stay the same. – Acccumulation May 14 '18 at 17:03
1

Inflation is generally defined by looking at the relative change (that is, current divided by some reference amount) of the Consumer Price Index. The CPI is a weighted average of a basket of goods and services. It can be thought of as the "exchange rate" between dollars and a "commodity" that consists of this collection of goods (I put "commodity" in quotes because it is a compound value made up of all of these goods and services, and not all of them are commodities). The price of gold is the "exchange rate" between dollars and gold. The purchasing power of gold is the "exchange rate" between gold and the CPI. The value of gold to you is the "exchange rate" between gold and what you actually want. These four numbers are distinct, and can vary independently. Your purchasing patterns aren't going to be exactly equal to the goods and services that make up the CPI, so the value of gold to you will be different from what an economist would calculate its purchasing power to be. And the price of gold varies separate from the CPI.

A key point here is that inflation is often spoken as an across-the-board increase in prices, but the reality is that the marketplace involves a wide variety of prices that do not fluctuate in unison. When economists want to measure "inflation", they have to collapse all of those fluctuations down to one number. This number reflects some "average" price increase, but there is no single objective "right way" to average the increases, let alone an average that reflects every price increase. The price of gold can shoot up while other prices remain stagnant, or vice versa.

Gold is correlated with inflation, and over long time periods is somewhat stable. While currency has a general downward trend in value, gold has roughly the same probability to go up as it does to go down. While inflation is a relatively consistent, expected decrease in the value of currency, commodity prices are based on discounted expected future value, and thus do generally avoid consistent drops in prices, and so provide safety from inflation in some sense.

But while gold is a good hedge against inflation in expectation value, it's not a good hedge in terms of volatility. Here is a chart of gold prices for the last 103 years. Over the entire period, there's been a significant increase, even adjusted for inflation. But on shorter time scales, that's not always the case. From 1934 to 1970, for instance, was a 36 years period of almost constant decrease in price, and 1980 to 2001 was a 21 period of decrease. Those two periods alone make up 57 years out of the 103 years shown, so gold prices were falling for more than half the time. While over the whole period, prices increased by a factor of 2.76, the 5-month period from Sep 1970 to Feb 1980 saw the price jump by a factor of 9. That means that if just 5 months out of 103 years were ignored, the overall change goes increasing by a factor of 2.76 to decreasing by a factor of 3.26.

Note that buying gold is, in some sense, an "anti-investment". Your money is going towards having bricks of metal sit around rather than actually go towards something economically productive. Not only do you have opportunity costs (while buying gold would have gotten you a 163% increase in capital over the last 100 years, stocks would have gotten you over 60 000%, and with less volatility) you are paying direct costs such as storage fees.

0

Gold is very hard to understand from an inflation, interest rate and economic perspective. There are better answers on this site elsewhere about this, but it has sometimes done well during high inflation, deflation and stagflation. The only pattern where it tends to perform poorly is an economic boom. This does not mean it's always good during high inflation, but it can be and the same is true during periods of deflation and stagflation - it probably will do well, but that's no guarantee.

If you like contrasts, an interesting contrast with gold during high inflation is copper:

As a result of this connection, for every 1% annual increase in in consumer prices since 1992, copper's price jumped almost 18%.

It's interesting, but I question the author's time basis. Does copper do this over 100 years?

The same with gold: maybe it does well during some inflationary periods, but what if the one that's coming is when it perform bad?

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Everything has intrinsic worth, based on need and rarity. Air is cheap when there is lots- expensive if in short supply. Food too. 'what the market will bear'. Any two goods will fluctuate in value against each other on this basis. If society has an exchange system (money), inflation is normally a measure of the decreasing value of the currency against a basket of goods regarded as being 'normal consumption' for a citizen. IMHO the calculation is usually full of flaws, and never comes even close to my experience in practice.

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