Precious metals and deflation

It’s been a while, so I’ll bang on inflation/deflation a bit.  Notice I didn’t differentiate between Common and Austrian (see the definitions page), as this time what I’m on about will apply to both.

As a general rule, during times of inflation (and assuming your allotment of money doesn’t grow along with the inflation) it’s better to buy now instead of later — you’ll get more for your money.  And during deflation the reverse is true – it’s better to buy later when you can get more for your money provide your allotment of money doesn’t decline with the deflation.

Now prior to the 1900s, and even up to about 1930, precious metals (PM) – that is, gold and silver – were money.  So in general it was good to keep them during deflation and bad during inflation.  With, that is, a couple of caveats.  The first caveat is a spinoff of Gresham’s law – Bad Money drives out Good.  If both paper and PM are money, and the paper is anything BUT 100% redeemable in PM, then PM did better than paper either way.  This is especially true in the second caveat – hyperinflation.  Hyperinflation only seems to happen to paper (fiat) money (though when New World silver started flooding europe it came close).  And in hyperinflationary times, PM… evades the inflation.  That is, a “dollar” of PM pre-inflation would buy as much after the inflation, acting like a commodity even though it was money.  Of course, the more accurate description is that everything BUT the paper money stayed the same, and paper’s value changed due to a drastically increased supply.  Shift what’s on each side of the equation that way and you can see what happened.

But as I said, this seems to have changed a bit after about 1930.  Since then, PM developed a split personality.   It picked up its commodity aspect (the hyperinflation point above) across less severe changes.  Yes, this was heavily influenced by the fact that the world began disassociating the various currencies from gold and silver.

What this means is that to some extent gold’s price tended to climb during inflation and decline during deflation – moving counter to money.  Except, well, there are exceptions.

If a deflation is long or severe – say, more than a year or two and/or more than 5 or 10 percent in a year – then PM returns to being considered money.

Specific examples can be found in Japan and Hong Kong’s deflations of the 1990s/2000s.  In both, the amount of gold you could purchase with the currency increased (the price declined) for the first couple of years.  Then it stopped dropping.  And then, even while other commodities continued to get ‘cheaper’, gold (and to some extent silver) got more expensive.

Now I want to point out there are other causes.  As with all things that have people involved there is no such thing as a simple answer.  That said, so far all deflations I’ve examined since 1930 have the same pattern vs PM.  If it’s short and shallow, PM is a commodity.  If it’s long, or severe (or both), PM becomes money – and good money (better against the paper) at that.

Final interesting note.   Even though PMs vs short and shallow deflation currencies get cheaper (for that currency), the PMs increase in value after the deflation is done.

So… what does this mean?

If you’re expecting inflation, buy precious metals.

If you’re expecting deflation, wait a bit, then buy PM.  Oh, you can buy it right away and it’ll eventually recoup.  But there’ll be a window where the PM costs less with subsequently greater relative gains.  When should you buy?  Now that depends on your gambler’s nerves.

The “perfect” time is when it’s the lowest price possible.  The “certain” time is after you know there’s a recession ongoing.  The next-best “certain” time is to buy as soon as the price of gold starts climbing again – a reverse stop limit, basically.  (The gamble being, of course, two-fold.  First that it’s REALLY bouncing off the bottom and not a short reset, and second that there’s still PM to be purchased.)

And with all that said, I’m buying PM now.  See, we’re inflationary right now.  We’re probably going to go through a deflationary period, but not immediately.  And even though my gains won’t be great – heck, even though for a while it’ll look like I “lost” money – I’ll recover.  If not on the Gresham flip, then on the end-of-deflation growth surge.  I just can’t put all my spare in it.  Net result – PM is a certain (though probably not spectacular) win.

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