Is gold's problem really an impending deflation?

11:15a ET Saturday, July 28, 2007

Dear Friend of GATA and Gold:

GATA's friend M.L.B. writes:

"I have my own take on the recent decline in the price of gold -- the spectre of deflation.

"The creation of massive amounts of derivatives has added monstrous amounts of cash to the monetary sysem. This cash is on the books of hedge funds, traders, and other financial institutions. As markets collapse, such as the subprime mortgage market, other dominoes start to fall, like Alt-A mortgage loans and stocks.

"The results are a disappearance of currency from the monetary system and a smaller amount of cash in circulation. In this eventuality, which I think may be under way, all assets, including gold, are liquidated at lower and lower prices. And since there are fewer dollars chasing gold, the ratio of dollars to gold is lower -- hence deflation.

"That would be another explanation for gold's low price: impending deflation.

"I would be curious to know if you think my thinking has any merit.

"-- M.L.B."

Your secretary/treasurer replied to M.L.B.'s thoughtful note as follows.

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Some observers have speculated along your lines -- that in our system, money is actually debt and that the extinguishment of debt is deflationary, that deflation will occur unless money creation exceeds debt extinguishment.

This stands to reason and if it is happening it may reduce demand for gold -- IF gold is considered some ordinary risky asset and not rock-solid money in itself, better money than the sort offered by central banks. Central banks desperately encourage such thinking by suppressing the gold price and smashing away wildly at gold in times of market stress.

But the main determinant of the gold price in the short term and the main restraint on it remains central bank dishoarding, which will have to end when central bank gold reserves run out.

Some of us in GATA don't worry about deflation too much, figuring that the greatest and most reliable power of central banks is the power of monetary debasement. This power has been almost infinitely enhanced by digitization of the money supply -- there is now an infinite supply of zeroes available to central banks, and these zeroes don't even have to be converted to paper currency.

CHRIS POWELL, Secretary/Treasurer
Gold Anti-Trust Action Committee Inc.

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