One of the biggest arguments for gold is the protection from inflation. But why is gold a good hedge against inflation? What does that really mean? Why is that true? These are the questions that I want to answer with this article.
Actually the answer to these questions might be one of the most important factor when you are deciding if investing in gold is for you or not.
Before we can answer these questions I think it is very important to talk about what inflation is. Lots of people have a misconception of what inflation means, they think inflation is rising prices.
Rising prices is a side effect of inflation. To say that inflation is rising prices is like saying that loosing your hair is cancer. The rising prices is just an effect of inflation, just like loosing your hair can be an effect of having cancer.
So what is inflation then?
Let’s first have a look at the actual definition of what inflation is.
“Monetary inflation is a sustained increase in the money supply of a country (or currency area)”
As the definition says its an increase in the money supply.
The money supply is the the amount of dollars in existence. When you print more money, you create inflation. An effect of inflation is higher prices for the goods and services that you buy.
Lets have a look at an example
Okey, I’m going to describe a scenario that should hopefully clear up all the questions you have about what inflation is.
Imagine that there are 10 people stranded on an island. They each have $10 and there is one ticket out of there for sale. What do you think the price will be for the ticket? It’s probably going to be $10 right?
The reason why is because the people will bid up the price with their dollars until they don’t have anymore.
Now imagine that there is a person in a helicopter dropping money, $10 each to be specific. So now every person on the island have $20 each. How much do you think the ticket will go for now? Probably $20 right?
It’s still the same ticket but because each person now have double the amount of money the price for the ticket has doubled. The only reason why was because the money supply (amount of dollars) increased on this imaginary island.
This is the effect of inflation. Because the increase of the money supply there is now more dollars chasing the same goods and services (one ticket in this example). The goods and services haven’t changed, they are still the same. But because of the extra money the price of the goods and service rise.
Do you see what I mean now when I say that rising prices is a symptom of inflation? Rising prices is not inflation, an increase in the amount of dollars is.
Why is gold a good hedge against inflation then?
Okey so you have understood what inflation is. Inflation is just an increase of the money supply. Because they print more and more money the price of our goods and services are rising, including gold.
Everything is going up in price today. Have you realized how much less groceries you get for $100 today then you did 10 years ago? Have you noticed how much less gas you get for $20 today then you did 10 years ago?
The reason why is because our central bankers keep printing more and more money every second of every day which is pushing prices up. Just as it did on the imaginary island in our example above.
So technically even food would be a hedge against inflation. If you bought bread for $100 ten years ago you would have more bread then if you bought bread for $100 today. Meaning that you investment (the bread) have systematically gone up in price because there is more dollars in circulation. Bidding the price up even though the bread haven’t changed.
But obviously bread would go bad pretty quick and 10 year old bread would definitely not be good to eat. So I don’t suggest that you should invest in bread.
The beauty about gold is that it doesn’t go bad, it doesn’t corrode. The gold that the Egyptians were using in trade 5000 years ago is still with us today. It might have been melted down into a jewelry or a bar but it’s still the same gold and it still shines just as good as it did 5000 years ago.
This is why gold is a good hedge against inflation. When our central bankers keep printing money and create inflation prices will rise for everything. And gold will not go bad over how many years you will keep it. Therefore you can buy gold and put it away and watch the inflation making it go up in price.
Have a look at this long term chart of the price of gold. Gold is going in one direction over the long term, and that is much higher! Check out my long term gold price forecast for my take on how high the price of gold can be.
How much are we increasing the money supply?
Alright, we know what inflation is. It’s the increase of the money supply. We also know that because now more paper dollars are chasing the same gold the price of gold will keep on rising with inflation.
But how much are we actually increasing the money supply?
All the way since the creation of Federal Reserve in 1913 the US central bank has constantly been increasing the money supply. But in the beginning it has been done in a slow pace to not let the people realize that their wealth is getting eaten up by inflation.
But since the financial crisis hit in 2008 the central banks around the world (the US central bank, Europe’s central bank, Japans central bank and yeah pretty much every central bank in the world) has been creating money (inflation) like it’s going out of style.
I mean have a look at the chart below which is the total amount of dollars in circulation. Since 2008 they are creating more money like never before.
When you listen to our central banks and the mainstream economist there is nothing indicating that they will cut back on their money printing. They will keep throwing more and more paper dollars at the problem and hope that it goes away.
This is terrible for the overall economy because the goods and services that the ordinary people buy becomes more expensive so we can buy less and less stuff every year.
So we know that gold will rise in price with the creation of inflation. We know that the monetary policy from our central bank is to just keep printing more and more money generating more inflation. Which in turn will make gold prices go even higher.
With this post I hope that I have proven the point of why gold is a good hedge against inflation.
My final question to you then is: Why aren’t you owning some physical gold to protect yourself from inflation?
Please leave the answer to that question below in the comments. Or any other input you might have.