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What If Deflation Wins?

What If Deflation Wins?

By Hard Assets Alliance Team

Since writing last month that inflation was on the rise, things have taken an abrupt turn. Look at the deflationary actions that have recently taken place:

  • The US dollar has shot up

  • The US bond market has rallied

  • Precious metals prices have collapsed

  • Base metal prices have fallen

  • Stock markets have declined

  • Oil and other commodities have fallen.

Further, just last week the International Monetary Fund cut its global economic growth forecast for the third time this year. Why? It doubts how quickly “rich countries will be able to pull free from high debt and unemployment in the wake of the 2007-2009 global financial crisis.”

It’s hard to argue that high debt levels are deflationary. And with the current expansion based largely on debt, we can’t expect sustainably higher economic activity to be generated.

So what happens if deflation wins? Even if we eventually get inflation, what happens to our gold investments if we first go through a deflationary bust?

There aren’t a lot of modern-day examples of deflation. The Consumer Price Index (CPI), as faulty as it may be, has registered only three declines since 2000, and all were short-lived. The CPI fell:

  • August to October, 2006

  • July to December, 2008

  • March and April, 2009.

That’s it. You can find other fleeting periods further back, but nothing long enough to draw any strong conclusions.

The only example we have of true deflation is the Great Depression.

The Great Depression Speaks

You’ll recall that the United States was on a gold standard at the time. But there’s still a lesson to be learned about gold and deflation…

On April 5, 1933, President Roosevelt issued an executive order forcing delivery (confiscation) of gold owned by private citizens to the government in exchange for compensation at the fixed price of $20.67/oz. Less than nine months later, he raised the gold price to $35, effectively diluting the dollar in every wallet 41% overnight and swindling everyone who had turned in gold. So even in the midst of one of the biggest deflations the world has ever seen, the government raised the gold price.

We don’t know exactly what an untethered gold price would have done during the Depression, but given its distinction in history as a store of value, it’s likely to retain its purchasing power in a deflationary setting regardless of its nominal price. In other words, while the price of gold might not rise or could even fall, it would still provide monetary protection against an unstable economic environment, especially when you consider that most other assets would be in decline.

The Gold Rush of the Great Depression

Perhaps a more direct example is the miners. It was the only way citizens could effectively own gold after Roosevelt’s confiscation. The comparability isn’t perfect, but again, there’s something to learn.

When the stock market crashed in 1929, gold stocks were part of the general wreckage. The market then rallied and recovered almost 50% of its losses by April 1930, with gold shares again tagging along. It’s what happened next that gives us another clue about gold and deflation…

When the bear market resumed in the summer of 1930, all securities sold off again—except gold stocks. Gold shares stayed basically flat until early 1931, when their appeal to the masses kicked into high gear.

Look at how shares of Homestake Mining, the largest gold miner in the US at the time, and Dome Mines, Canada’s senior producer, performed during the Great Depression.

Company Stock Price
Stock Price
$65 $373 474%
$6 $39.50 558%


During a period of soup lines, crashing stock markets, and falling standards of living, investors fled to the only gold they could own at the time.

Yes, volatility was high throughout the Depression, with occasional wild price swings, but after the 1929 crash most of the volatility was to the upside.

From Homestake’s chart, you get a clear picture of the rush to own gold compared to the market as a whole:

Notice the large spike down in both Homestake and the Dow during the 1929 crash—but then look at Homestake’s recovery immediately afterward, returning close to its old high. You’ll then notice the stock took almost two years to exceed its old high, but once it broke out, it was off to the races. The stock doubled four times in five years during a seven-year run to its peak after the ‘29 crash.

The conclusion? If history is any guide, gold can hold its own against deflation. Its status as a safe-haven asset during one of the greatest times of economic distress was demonstrated clearly by investors buying the stocks.

All this said, the overriding concern is that in a fiat system, any deflation will be met with an inflationary overreaction. And the worse the deflation, the more extreme the overreaction will be. QE5, anyone?

There’s turmoil ahead, and almost certainly another crisis. The recent decline in the gold price has only served to make our insurance cheaper. Accumulating physical bullion will offset whatever form that crisis may take. The Hard Assets Alliance can help, learn how.

This article was published in the October issue of the SmartMetals Investor—a free, monthly newsletter from the Hard Assets Alliance featuring the precious metals news and commentary investors need today. The full issue—including the real reason to own precious metals, why the strong dollar will pass, and what that means for gold, and a silver lining for silver—is available now with free sign up to the SmartMetals Investor.


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Reader Comments (1)

They have been overly worried about creating inflation and this dilemma is what they get. US needs a jobs program stat. Too many idle hands aren't good for democracy either.

October 18, 2014 | Unregistered CommenterPete

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