The Historical Ties between the ‘Deflationists’ & the ‘Gold Bugs’
The seemingly perennial inflation vs deflation debate is littered with mutually antagonistic groups. The two most notable combatants seem to be the ‘Deflationists’ and the ‘Gold Bugs’. In the interest of being a lover and not a fighter, I thought I’d outline the historical ties between these two groups and explain why the widely publicized misgivings between them may be misplaced.
The Seeming Contradiction:
If I were to hazard a guess at the most commonly held beliefs relating to deflation and gold, I would say that the two assets are regarded as mutually incompatible. Gold — it is said — is an ‘inflation hedge’, and thus cannot possibly be favored by the steadfast deflationist! Likewise, if you have a long position in gold, you’re surely a gold bug that eats deflationists for dinner, right?
But wait… ‘Gold Bugs’ used to be the ‘Deflationists’!?
It is important to note that currency systems as we know them today – that is, irredeemable fiat currencies – are a relatively new thing. The time-honored monies of the world have been the precious metals. Historically, then, the money supplies of the world have consisted of gold and/or silver (in their metal forms) as well as ‘IOU claims’ upon those metals (in the form of notes or checking deposits at banking institutions).
So, back in the day, the investors that believed that the mountain of ‘IOU claims’ upon ‘money’ (back then, gold and/or silver) were faltering, were — you guessed it — gold bugs! As Irving Fisher explained in ‘The Money Illusion‘ (available at the greshams-law.com book store):
When the price level is falling, the money-lender (the bondholder) is getting the advantage of the changing conditions and the public nickname him, as in the Bryan days of 1896, the “Gold Bug of Wall Street” or the “bloated bondholder.
Essentially then, the rudimentary event that the ‘deflationists’ fear may come to pass (the mass extinguishment of ‘IOU money’), is exactly what the original ‘gold bugs’ feared most of all!
Have things changed all that much?
Now, I know that the gut-reaction is to say; ‘well, things have changed, we’re in the modern world, … ‘, and although I grant those statements, I humbly request that you consider the following questions: Isn’t it strange that the ‘gold bugs’ and the ‘deflationists’ should be considered polar opposites given that they were one and the same thing not so long ago? Moreover, isn’t it strange that – for example – George Soros would sell his gold for the reason that he no longer believed that deflation (that’s right, not inflation) would come to pass?
Reconciling the ‘Deflationist’ & ‘Gold Bug’ Positions:
As is often the case with such arguments, it pays to look at the terms in which the arguers are speaking. Here, the tendency to conflate notions such as inflation, monetary debasement, increases in the ‘money supply’ and increases in a ‘consumer price index’ seems to hold the key. If you can wrap your mind around the fact that gold is not an inflation hedge (in the sense of hedging against consumer price index increases) — and yet that it is a hedge against monetary debasement (in the sense of central bank balance sheet expansions), then I think you’ll get on the right track.
Since the World’s currency systems are irredeemable, there is no danger of an explicit run on central banks. However, given that the price structure must – in some sense – reflect the fact that the dollar, euro, pound etc. are at most as good as what backs them, there are consequences to balance sheet expansions. Instead of a run when Central banks print money, we often have to see a rise in central banking liability price (e.g. federal reserve note price) of central banking assets (which — of course — includes gold).
Commercial banks are required to redeem into central bank notes (i.e. federal reserve notes, euro notes, pound sterling notes etc.), and therefore are potentially subject to bank runs. A means by which central banks aim to avoid such bank runs (after all, ‘the whole world will end if we let that happen!’), is by monetary debasement – i.e. by increasing the size of central bank balance sheets.
You see, the prospects of embracing gold and being very wary of credit contraction (or, in Austrian terms, the mass retirement of Fiduciary media) are mutually compatible ideas. In fact, we here at greshams-law.com would go as far as to say as they are inseparable and that they spur each other on! Deflationary credit contraction is capable of being averted by monetary debasement. Yet that monetary debasement is incapable of correcting the inappropriate time-structure of production that the fractional-reserve banking system produces. Inevitably then, insofar as the reaction to potential bank runs remains that of extreme and widespread petrification, continued monetary debasement is likely to follow.
The ‘deflationist’ and ‘gold bug’ intellectual positions aren’t too distant from one another. We’re all brothers even though we’re from other mothers – so let’s be friends, yah?
Recommended: Charting the Federal Reserve's Assets - 1915 to 2012