Gold As A Stagflation Hedge (Part 4)

(The following is the fourth of a five-part series on how gold performs during periods of deflation, chronic disinflation, runaway stagflation and hyperinflation. The fourth installment examines gold’s safe-haven role during a hyperinflationary breakdown.)

ANDREW DICKSON WHITE ENDS HIS CLASSIC HISTORICAL ESSAY on hyperinflation, “Fiat Money Inflation in France,” with one of the more famous lines in economic literature: “There is a lesson in all this which it behooves every thinking man to ponder.” The lesson that there is a connection between government over-issuance of paper money, inflation and the destruction of middle-class savings has been routinely ignored in the modern era. So much so, that enlightened savers the world over wonder if public officials will ever learn it.

White’s essay tells the story of how good men — with nothing but the noblest of intentions — can drag a nation into monetary chaos in service to a political end. Still, there is something else in White’s essay — something perhaps even more profound. Democratic institutions, he reminds us, well-meaning though they might be, have a fateful, almost predestined inclination to print money when backed against the wall by unpleasant circumstances.

If there is a hyperinflationary shock in the United States, the opening salvo would probably be a sudden undermining of the dollar’s status as the world’s reserve currency. Up until recently, the United States enjoyed a strong world-wide demand for its government paper. Thus, the negative effects of government deficits have been subdued. Now, with consistently low interest rates and a growing fear globally that U.S. deficits may have run out of control, foreign support for the U.S. bond market has faltered. In the absence of international buyers, the Fed already has been forced to monetize an ever larger portion of the debt — the modern equivalent of printing money. Whether or not it can follow through on its promise to reduce government bond purchases in the face of lagging foreign demand remains an open question.

Though the global demand for dollars remains the principal factor standing between relative calm and monetary mayhem, an inflationary surprise could come from another direction entirely. With nation-states around the world engaged acutely in the money printing game (and in deadly competition with one another), one cannot rule out the possibility of a generalized global descent into the inflationary abyss — at first slowly, then more rapidly until a large portion of the world’s population awakens one day to a global hyperinflationary breakdown.

Episodes of hyperinflation ranging from the first (Ghenghis Khan’s complete debasement of the very first paper currency) through the most recent (the debacle in Zimbabwe) all start modestly and progress almost quietly until something takes hold in the public consciousness that unleashes the pent-up price inflation with all its fury. Frederich Kessler, a Berkeley law professor who experienced the 1920s nightmare German Inflation first-hand, gave this description some years later during an interview published in Ralph Foster’s book, “Fiat Paper Money: The History and Evolution of Our Currency” (2008): “It was horrible. Horrible! Like lightning it struck. No one was prepared. You cannot imagine the rapidity with which the whole thing happened. The shelves in the grocery stores were empty. You could buy nothing with your paper money.”

Towards the end of “Fiat Money Inflation in France,” White sketches the price performance of the roughly one-fifth ounce Louis d’ Or gold coin:

“The louis d’or [a French gold coin weighing.1867 net fine ounces] stood in the market as a monitor, noting each day, with unerring fidelity, the decline in value of the assignat; a monitor not to be bribed, not to be scared. As well might the National Convention try to bribe or scare away the polarity of the mariner’s compass. On August 1, 1795, this gold louis of 25 francs was worth in paper, 920 francs; on September 1st, 1,200 francs; on November 1st, 2,600 francs; on December 1st, 3,050 francs. In February, 1796, it was worth 7,200 francs or one franc in gold was worth 288 francs in paper. Prices of all commodities went up nearly in proportion. . .

Examples from other sources are such as the following — a measure of flour advanced from two francs in 1790, to 225 francs in 1795; a pair of shoes, from five francs to 200; a hat, from 14 francs to 500; butter, to, 560 francs a pound; a turkey, to 900 francs. Everything was enormously inflated in price except the wages of labor. As manufacturers had closed, wages had fallen, until all that kept them up seemed to be the fact that so many laborers were drafted off into the army. From this state of things came grievous wrong and gross fraud. Men who had foreseen these results and had gone into debt were of course jubilant. He who in 1790 had borrowed 10,000 francs could pay his debts in 1796 for about 35 francs.”

Those two short paragraphs speak volumes of gold’s safe-haven status during a tumultuous period and may raise the most important lesson of all to ponder: the roll of gold coins in the private investment portfolio.

Most Americans take the attitude that “it can’t happen here”, but the truth of the matter is that no economy or monetary system is immune to the ultimate effects of printing too much money. “Like previous hyperinflations throughout time,” says Patrick Barron, an economics professor at Wisconsin University’s Graduate School of Banking in a paper published at the Ludwig von Mises Instiutite, “the actions that produce an American hyperinflation will be seen as necessary, proper, patriotic, and ethical; just as they were seen by the monetary authorities in Weimar Germany and modern Zimbabwe. Neither the German nor the Zimbabwean monetary authorities were willing to admit that there was any alternative to their inflationist policies. The same will happen in America.” The official mindset that unleashes the hyperinflation is already present in U.S. monetary policy and to think it might be suddenly brought to heel could become the source of our undoing. History tells us that once the inflationary genie is out of the bottle, it is difficult to get it back in.

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Michael J. Kosares has over 40 years’ experience in the gold business. He is the founder and executive director of USAGOLD (both the website and gold brokerage service), the author of three books on the gold market, and the editor of "News, Commentary & Analysis," the firm's client letter. He has written numerous magazine and internet essays and is well-known for his ongoing commentary on the gold market and its economic, political and financial underpinnings. Visit his website at www.usagold.com.