No Golden Parachute On The Flight To Safety

TWO BIG PROBLEMS

The price of gold spiked upward by $40 oz. on Friday. Reports by others point to the failure of Silicon Valley Bank (SVB) as sparking a "flight to safety" into the yellow metal. Gold, according to them, is the ultimate safe-haven hedge; where else would you go?

There are two big problems with that logic...

FIRST PROBLEM

The first problem is that investors, for the most part, don't buy gold "to be safe"; they buy gold because they expect its price to go up. What if it doesn't?

Last year at this time, the gold price was accelerating due to investors concerns about the Russia-Ukraine war. After coming close to matching its previous peak of over $2000 oz., gold's price dropped more than four hundred dollars within the next few months to a three-year low.

On the other hand, why should its price go up because of a flight to safety? The only reason the price of gold goes up over time is to reflect the loss in purchasing power of the U.S. dollar that has already occurred - nothing else.

SECOND PROBLEM

The second problem is that apparently investors presume that implications of potentially serious economic problems associated with the SVB failure, are indicative of problems for the U.S. dollar and hence, beneficial for the gold price.

Not so. Silicon Valley Bank, as do all banks, operate under a fractional-reserve banking system. Currently, banks are required by the Federal Reserve to maintain reserves of only ten percent of deposits on hand. The rest can be lent out.

A ten percent reserve does not leave much room for error. If only a few too many people want their money at the same time...

Well, you get the picture; but there is more to the story.

In order to satisfy withdrawal demands of its depositors, Silicon Valley Bank was forced to liquidate reserves that were held in U.S. Treasury bonds. Those bonds were sold at a significant loss (as much as 20-30 percent) due to the decline in existing bond prices associated with the trend of higher interest rates over the past two years.

The SVB failure is evident of actual destruction of capital/money. As far as the U.S. dollar is concerned, the events are more implicative of deflation (a stronger U.S. dollar) - not inflation.

The gold price during deflation would decline. Even without deflation, there would have to be a renewed decline in the U.S. dollar of lasting impact before the gold price could exceed $2000 oz. and move higher.

CONCLUSION

Any domino effects from SVB could lead to further selloffs in stocks and other financial assets. More bank failures and a financial asset price implosion are possible.

In that case, gold will not protect you, as it will continue its price decline in real and nominal terms.

The Fed and the U.S. government could respond at some point similarly to their efforts in 2008-10 and in 2020. Such an effort could bring about renewed rejection of the U.S. dollar and much higher gold prices.

That doesn't mean their efforts would be successful, any more than they have in the past; and likely less. That is because their efforts are having less and less impact over the decades.

Buy gold as a long-term store of value. Have some cash on hand, too. You will probably need it.

Final note about SVB: expect more surprise events of a similar nature.

(also see: Default, Deflation, Depression and Effect of Deflation On The Gold Price)

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN'T, AND WHO'S RESPONSIBLE FOR IT and ALL HAIL THE FED!

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