Is Gold an Inflation and Volatility Hedge?

An acquaintance recently pointed me to the following article:

Essentially, it dismisses the idea that gold is an inflation and volatility hedge.

Though I find myself partial to gold (and silver….ever held bullion of gold or silver?! ‘Tis Cool…!!), I have to honestly agree.

BUT I must add that the wider economic context is CRITICAL, and cursory glances at selected historical trends (such as is done in the above article) miss so much key, general, macro-economic information – even elements such as, “Do people still value other things? And to what degree, relatively speaking?”

Anyhow, I’ve responded to my acquaintance with the following.


Fundamentally, in economics, and throughout history, gold has been (and is) a CURRENCY. Has been for thousands of years. Silver even more so.

Gold (and silver) is also a commodity, meaning it has practical purposes other than as a currency. The price of Gold (and silver) will reflect a balance between its currency supply-demand balance and its commodity supply-demand balance.

But the biggest thing about Gold as a currency is: You can’t print it, like you can with “fiat money“.

You CAN lose confidence in it though, just like any other currency (or commodity); and confidence is key to value.

What that article doesn’t seem to appreciate is that the small historical reference windows considered don’t have a significant loss of faith in the US Dollar – which is the currency that gold is (and was) currently relatively measured against.

However, even taking the view of the limited-window approach that i just criticised (which generally fails to consider many other macro-economic factors), if we DO consider “recent” periods where people have lost significant faith in the power/stabilty/etc/etc of the US dollar, then we see that gold rises accordingly.

For example, in 1980, the market lost significant confidence in the US dollar, be it for only a short period of time, and look what happened! …

In real (inflation-adjusted terms), this is the highest ever gold price (today is only about half of what happened in 1980!)

In the USA in the late 1970’s and early 80’s inflation was “very high” – often some 10-20%, I believe.

What does inflation effectively do? It reduces the purchasing power of money – a dollar buys less than it did before. So, what is the effect of this? Inflation devalues a currency. Simple.

So, as the currency rapidly devalued, people lost confidence in it, and moved their money to another denomination, even if it was only for a relatively short period of time: gold.

But people quickly regained confidence in the US dollar as, i believe, the Feds stepped in an jacked up the interest rates and reduced the circulation of money.

What does this mean in terms relevant to this discussion?

Interest rates are, in effect, an expression of how much the issuer/controller and populace using the currency actually VALUE to money. ie. higher interest rates indicate a higher perceived value, whilst lower interest rates indicate a lower perceived value.

…And, at the end of the day, it’s all about the perceived value of the value-carrying-medium, in this case, cash: US dollars.

The US Feds also quickly reduced the pool of circulating money – less cash around, meaning each dollar that you have is effectively worth more…concentration of value, effectively, as the opposite was occurring with high inflation – expansion of the money pool (so to speak), and this was devaluing the currency.

So, the market quickly gained confidence in the value of the US currency, the US dollar, as the Feds expressed their perception of its value (and th market agreed), but only AFTER the market fled to gold to retain intrinsic/perceived value, then sold out of gold and back into the US dollars they now trusted again.

Therefore, I assert, in the 1980 scenario, both inflation AND a loss-of-confidence in the US dollar sparked a run to gold as a “hedge” against US Dollar depreciation (where gold was/is just one of many alternatives, really).

So, gold can be an inflation hedge IF a loss-of-confidence accompanies it, in my honest opinion. Similarly, relatively low inflation in a currency is not likely to cause a “rush” to an alternative (such as gold), as their may not be a significant-enough loss of confidence. But, interestingly, a loss-of-confidence (for a variety of reasons) may actually cause inflation…

The truth is, people can “run” to whatever they want as a hedge when the relative value of their current store of value is depreciating – coal, iron ore, wheat, soy, property, shares, gold, silver, diamonds, etc, etc, etc.

The problem with running to the commodities could be that if the general economic environment is not right, then a bubble might be created, and then deflate very quickly, catching out those who actually ran to it for safety. This is especially a problem in a general economic environment experiencing “debt deflation“, where pretty much EVERYTHING is devaluing – some things more than others – due to a “crunch” in debt-related circumstances (ie. a heavily cranked-up economy(s), with debt-growth slowing from previous and/or “going bad” for whatever reasons….sounding eerily familiar to today?)

But what Gold and silver have going for them is their rarity and desirability as alternative CURRENCY, as readily accepted mediums of value – not just as commodities. That’s why, generally, when there is a genuine crisis in the confidence of a “fiat” currency, people run to gold (and silver, too).

Once confidence in a fiat currency is restored – ie. the factors that eroded confidence in it in the first place or largely gone – then gold and silver will devalue relative to them. Exactly what we see in recent economic history.

Hence, gold (and silver) can be an inflation and volatility hedge in the right economic context!

Take with a grain of salt those articles written by people who refer to some historical details, as if the past is necessarily the key to the present, and sound all authoritarian (even me!).  At the end of the day, economics, and all that it entails, is an exercise in real-world, applied PSYCHOLOGY, with “value” rooted in “values” and “worldview”.

Thought the specific can be tricky – and even near-impossible – to pick the exact specific values and timing, the general long-term trends are easier to pick if you put on your Wisdom Cap.

Cheers for now,




One Response to Is Gold an Inflation and Volatility Hedge?

  1. Pingback: Alan Kohler, the deflationist...

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