Conventional wisdom has appraised the value of gold using a zero-sum formula that, put simply, states that buying gold during a period of inflation is good, while buying gold during a period of deflation is bad. This is because during a period of inflation, gold rises as the dollar falls. The converse is true under deflation – when the dollar rises, the price of gold falls.
However, instead of seeing the value of gold through this old-fashioned, black-and-white lens, investors should consider gold’s store of value relative to other investments. In this article, we will break down gold's purchasing power relative to consumer prices and why gold investments during deflation might be a smart option after all.
What Defines Deflation?
A global economic downturn that results in a drop in consumer prices is a defining characteristic of deflation. In addition, deflation results in a decrease in wages and an increase in unemployment. Deflation is determined using the consumer price index (CPI), which indicates if overall prices are rising (inflation) or sinking (deflation). During a period of deflation, consumers can expect to see prices on goods, products, and services reduced.
Although some savings become possible in one area of the market, consumers may see an increase in prices for goods and services offered by other industries in response to the price drops in other areas. This is where the relative purchasing power of gold comes into play.
Are We Currently in a Period of Deflation?
Roy Jastram, a recognized authority on the gold standard and author of The Golden Constant: The English and American Experience, 1560-1976 has some interesting views on the prices of gold through economic cycles. More specifically, the book examined three major deflationary periods in US history:
- 1814-1830. During this period, the record shows prices fell 50% over those 16 deflationary years.
- 1864-1897. During this second period of deflation, prices fell 65%.
- 1929-1933. This final deflationary period was recorded during the locust years of the Great Depression. During those four years, prices sank by 31%.
Although we have not seen a period of deflation since the Great Depression according to the metrics used, some consumers and economists are wondering if the COVID pandemic could spur a new era of deflation. If that’s the case, is investing in gold a wise choice to better position yourself financially?
Is It Smart to Invest in Gold During a Period of Deflation?
So what happened to gold’s purchasing power during those periods of deflation? Jastram’s findings may surprise you.
During the first period, between 1814 and 1830, prices on consumer goods fell 50%. Gold's purchasing power on the other hand increased by a staggering 100%. This means that the overall purchasing power of gold bought twice as much.
From 1864 to 1897, overall prices sank by 65% while gold’s purchasing power rose by 40%.
Last, 1929 to 1933 saw prices decrease by 31% while gold’s purchasing power increased by 44%.
Jastram’s findings all indicate that investing in gold during deflation is a financially savvy decision.
What Metrics Should Be Used When Determining Gold’s Store of Value?
Investors must consider gold’s nominal prices versus its purchasing power. Nominal pricing shows us the unadjusted rate or current price, without taking inflation or other factors into account. Purchasing power refers to the value of a currency expressed in terms of the number of goods or services that one unit of money can buy. Purchasing power is important because deflation increases the number of goods or services you would be able to purchase.
From 1800 to 2010, gold's nominal price may not have consistently risen, but gold commanded a stronger purchasing power due to its ability to afford more goods each time. It was found that even under deflation, gold is precious and serves as a trusty store of wealth due to its relative purchasing power.
Does gold hedge against deflation?
During inflation, the purchasing power of a country’s currency falls, leading investors to flock to assets that historically have retained their value during economic instability. Gold has a storied reputation as a store of value, making it an attractive option for investors hoping to hedge against inflation.
Gold has historically held an inverse relationship with the economy. As inflation rises and the value of a fiat currency decreases, the price of gold increases. While this relationship is not foolproof, it is a common trend within the market, giving gold a reputation as a safe-haven asset.
What is the best investment during deflation?
The best investment during deflation will depend on an individual's own financial goals, circumstances, and tolerance for risk. Holding onto cash can preserve its purchasing power during times of deflation. However, you won’t see as high of a return as you potentially could with defensive and high-quality dividend stocks. Precious metals like gold and silver are also safe bets during times of economic uncertainty, as they hold intrinsic value.
Is gold better in inflation or deflation?
It’s wise for any investor to understand that precious metals and their performance during any economic turbulence can be influenced by a variety of factors, including the market and investor sentiment. During deflation, gold and other precious metals can be used as hedges, but their performance is less consistent during deflation compared to inflationary periods.
Who Should Consider Buying Gold During Deflation?
The end of 2009 saw gold trading at $1,096 an ounce. The price currently hovers around $1,800 an ounce. Gold’s value increased by about 80% over about ten years. Those with disposable income should highly consider investing in precious metals as a long-term investment, as gold’s store of value has been able to withstand the test of time. Those looking to diversify their asset holdings will also want to consider adding gold to their investment portfolio.
Why Trust the U.S. Gold Bureau to Help You Make Sound Investment Decisions?
Since 2003, our philosophy at the U.S. Gold Bureau has always been to serve our customers with an emphasis on education, personal attention, and respect. We aim to bring trust and integrity to all aspects of the precious metals acquisition process, continually raising the bar to provide a premier gold investing experience.
We are a highly secure precious metals storage facility in the country, and each of our Precious Metals Specialists have been through extensive training. They’re well-equipped to assist you at all stages of the gold-buying process, and can provide expert advice. We are directly compliant with all gold-industry standard rules and regulations of the Federal Trade Commission, as well as the top associations and governing bodies of the precious metals industry.
Reach out today for a consultation with one of our Precious Metalist Experts to see how investing in gold can put you in a better position financially.