Bull, Could you elucidate? I don't quite understand what they are saying: "...So many risk-averse investors are shunning currencies and turning to an old favorite: gold. Yet, rationally, that's an especially odd choice. Gold is traditionally an inflation hedge, not a deflation hedge. The market for the metal itself is very illiquid, although the development of exchange-traded funds has opened up a good proxy. And of course gold doesn't earn any income." Pablo

Pablo, First of all, you are listening to a writer who knows absolutely nothing about gold or the history of gold except what he's read in a few paragraphs in college economics classes and who is probably younger than you or I. Imagine me starting a piece, "Now let me tell you all a little bit about the history of Spain..." Having the understanding of Spain through your ancestry and heritage, you would probably laugh. And for good reason.

Anyway, here is what he is saying:

Risk averse investors are getting out of paper currencies and choosing gold. He sees this as not a good choice, because gold is traditionally an inflation hedge. This means people buy gold to protect their purchasing power in times when currency values collapse, i.e. inflation gets out of control. This is what happened in Argentina, as the peso lost value, and prices went up, up, up, gold maintained it's purchasing value and went up with the prices of everything else ( as valued in pesos). In other words, it acted as an inflation hedge.

HOWEVER, gold is also and has traditionally been a deflation hedge as well. The only reason this guy doesn't know this is that during his lifetime, most currency events have been inflationary related to the dollar, and other currencies, because the dollar has been the world's reserve currency since 1944 (backed by gold) and since 1971 (not backed by gold).

Anyway, gold has always provided protection against deflation as well, just as it did during the Great Depression in this country, which happened probably about 40 years before this guy was born. This is why FDR issued an executive order to confiscate gold, because people were using it to protect themselves and their purchasing power. By Gresham's law, bad money was driving out good money and gold was disappearing from circulation as people hoarded it. Why were they hoarding it, because it was going up in value during a deflationary period. It was acting as a deflationary hedge, a way to store wealth when the prices of everything else were collapsing.

When fiat currencies collapse after a period of hyperinflation or without a period of hyperinflation, the money supply collapses and the value of gold rises tremendously. From a historical standpoint, during periods of deflation, gold always rises in value, because historically periods of deflation always involved currencies that were tied to gold. It is only now that currencies not tied to gold are still valued as money that observers like this guy believe that they will maintain value despite excessivequantitative easing, i.e. money printing.

This will not happen.

Americans believe and hope it will happen, because they believe that there is something special about the dollar that makes it more than a piece of paper.

There is not.

Gold is gold with intrinsic value based on thousands of years of history. The dollar is a figment of our government's and our people's imagination. When they lose faith in it, its value will collapse and gold will increase in value. The only way gold could suffer in the face of deflation is if the supply of dollars were really decreased, i.e. the dollar strengthened against gold and gave us a viable alternative to gold as money.

However, this would mean increased interest rates as the value of dollars would go up. Interest rates, the amount of money someone pays to borrow dollars would reflect a greater value of the dollar. (The more valuable a thing is, the more you would pay to use it, correct?)

This is why it is silly for someone to claim that the dollar is getting stronger in a low interest rate environment. The dollar might temporarily be getting stronger against other currencies that are valued based on the dollar standard, but so what? This is like me saying I am the strongest man in the world, because there are only 5 other people in the world, and I am stronger than all of them. My assessment of the situation may indeed be correct, but the underlying premise is flawed. Yes, the dollar might be the best money in the world when compared to the Euro or the Zimbabwe Dollar, but that doesn't mean it is the best of all monies or even a real money. Just because I beat up 5 12 year old boy scouts in a boxing match doesn't mean I'm the strongest man in the world. It might not even mean I'm a very strong man.

About his comment that the gold market is illiquid. Nothing could be further from the truth. Sure you can't exchange gold on every street corner like you can dollars, but that doesn't mean it's illiquid. An illiquid market is something like baseball cards or real estate, where ready buyers and sellers aren't always available. That's not a problem with gold.

Dean, my gold guy pointed out very clearly, also, the simple truth that as hyperinflation ensues or currencies weaken, the liquidity of gold increases exponentially as black markets pop up everywhere. If dollars were to suddenly disappear, things would suddenly start to be priced in other objects, perhaps silver and gold, but maybe not. Maybe bamboo shoots or garden chairs. People's thinking would suddenly change. Right now, we price things in dollars, because that's what we're used to. If we were to price things in gold today, we would first mentally think of how much things are worth in dollars then convert that to gold in our heads. If dollars were to be gone, we would develop some other standard of measurement, most likely silver units of some sort with gold units above that. we would start pricing things in ounces of silver or pieces of silver in order to carry on the activities of daily living that involved commerce or trading, i.e. just about everything.

When this guy is referring to liquidity, he is referring to how quickly one can change one form of investment to cash. When he refers to the Exchange Traded Funds, like SLV and GLD, he is referring to supposedly backed by most likely non-backed paper shares that represent part ownership in bars of gold and silver that trade on the exchange like stock shares.

This is interesting and shows the limitations of this young writers economic education. He is mistaking liquidity for value. In a monopoly game, properties are extremely liquid, but they have no real value. Would you rather have an illiquid investment that had real value, like a farm in the middle of a depression or a perceived liquid investment that has no real value, i.e. 5,000,0000 gum balls. When a depression hits, you might not be able to sell your farm, but you can use the land to sustain yourself. You might be able to unload 5,000,000 gum balls in a day right now with the right distribution system, but when tough times hit, who will want them? Today they are very liquid, tomorrow, they are not only illiquid but worthless.

And yes, of course, gold doesn't earn any income. But neither does a money market fund getting 2% if inflation is 3%. This is what's called a negative real rate of interest. Savings are not designed to make money, they are designed to preserve wealth, to "save" purchasing power. There should be no risk. If one is making interest, then one is assuming risk. So gold is a risk- free savings vehicle. A money market fund or a bank account is not, even if it is insured by the FDIC. The only way any savings vehicle that does not have intrinsic value can be risk free is for someone else to assume the risk, i.e. pay the insurance. This is how inflation works. When something goes wrong, the government simply prints more money to cover the costs. This is inflation by definition and is the insurance, i.e. how the risk is "covered" for all those who believe that they simply have a right to make money on the money they put into a bank, not realizing that the money they put into a bank is a gamble just like putting money in a slot machine is a gamble. Granted, it is much less of a gamble, but a gamble nonetheless. The writer of this article for the WSJ doesn't understand this, that is most likely why he is going to be blindsided when a true monetary crisis hits.

Bull