Friday, September 11, 2020

Gold as the currency of last resort against debasement risk


"I don't like dollars, but I also don't like any other currency..."

"Gold, when you absolutely positively cannot find another store of value ...."



Gold has stabilized over the last month within a range around 1950. This range has occurred even with Powell announcement of inflation averaging and other central banks clearly continuing quantitative policies to boost inflation. 



Of course, generating inflation has failed over the last decade, yet one of these times central banks may get it right and the gold rise of 2020 signals that gold buyers think they may be successful. Nevertheless, history has not been kind to believers in a gold and inflation link. Gold is a speculative investment that reacts to the changing sentiment of investors to a range of factors.

To appreciate gold moves, investors need to understand the subtle distinction between inflation and debasement of a currency. Gold has generally been viewed as an alternative currency that is driven by expectations for this alternative versus other currencies.

Investors are actually looking for a debasement hedge against stores of value that decay from negative real rates. Where do you place money when existing store of value decay? It is a relative decision which means that looking for a  gold and inflation link is not good enough. 

Inflation is simply an imbalance between supply and demand in the aggregate goods market caused by excess money. If there is economic slack, there is unlikely to be inflation. There can be a relative price shock but no general price increase. A currency debasement is focused on a real or perceived destruction of conventional money as a store of value which can be easily transferred into other assets or used for payments. Someone may not want to hold dollars because he does not have faith in role as a store of value. It can be caused by inflationary expectations or a belief in the financial and political integrity of the issuer to honor political and financial commitments. 

The cost of holding gold when real rates move further negative across all major currency alternatives becomes easy. If there is a threat of currency debasement albeit low, then there will be an increased demand for an alternative currency of last resort. If other currencies have a similar threat, the choice for gold becomes clear. Negative real rates, high risk for liquid assets, and high macro uncertainty fuel speculative switching to other alternative stores of value. Given this focuses on the perceived likelihood of rare events, the link between gold and current macro data may seem tenuous, yet investor demand a new currency alternative.  


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