I hear many people predicting gold will drop below $500. If it does, it would represent the buying opportunity of a lifetime, perhaps of several lifetimes. Those who believe gold should not continue its bull market advance believe we are entering a long-term economic bust that will reduce demand for everything other than money and consumer essentials. Indeed that would be true should the government sit idle, and they’re not, but that’s a topic for another post. Even if we experience a long term quasi-deflationary bust, here is where their analysis is mistaken — they presume people will always consider dollars the best form of money. Some say, “inflation in what you need, deflation in what you don’t” and since gold isn’t edible the price should drop, but that assumes people don’t need savings. Of course people need savings, especially rich people, and when you have a distribution of income as unequal as today, that means an enormous amount of savings may be looking for a new home.
Should people insist on saving and the government insist on resisting their decision with inflation and quantitative easing, the most likely outcome will not be sudden enlightenment and a resurgence of unsustainable consumption, it will be a shift to alternate forms of savings: gold, food, fuel, etc. In fact, the more money is printed in a failed attempt to revive demand the more money will ultimately pile into alternate forms of savings, causing prices to rise even faster. If we intervene to “put out the fire” (and we are) the more ominous the risk of deflation, the more money is printed, the more gold will ultimately advance.
But that assumes people lose faith in dollars, even if the dollar doesn’t collapse and currency markets remain strong, gold can still advance. Other than a few years, commodities advanced throughout the 1930′s deflationary depression because supply dropped faster than demand.
But that assumes supply will drop, even if commodities don’t increase in price, gold can still advance. It’s not just a commodity, it’s an instrument of savings. Gold is money, just like dollars. If dollars advance in a deflationary bust, so should gold.
And remember, those are the deflation scenarios. There are just as many inflation scenarios, all of which also result in gold going up. And please take note of the irrelevance of “capacity” to this debate. Prices can rise despite spare capacity because the existence of capacity does not prove the existence of relevant capacity, factory A can not produce the same goods as factory B because they’re both called a factory. And the longer a factory sits idle, the more it costs to bring it back online.
Under what scenario would gold collapse? Legitimate economic growth. An economy with abundant savings, faith in its currency and abundant productivity improvements from successful companies doing useful things has a diminished need for gold. Since we’re reduced to identifying scenarios and guessing probabilities, I think everyone can agree that is the least likely outcome.
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