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Why Is Gold A Good Hedge Against Inflation?

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why is gold a good hedge against inflation

Prices are rising like a hot air balloon today. Why is that?

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.

Ben Bernanke dropping dollars from a helicopter

Central bankers dropping more paper money from a helicopter and thinking it will solve our problems. Do you?

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.

historical gold chart

Because our central bankers are creating inflation there is more dollars chasing the same amount of gold. Making the price go much higher.

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.

US monetary base

Look at the money creation since 2008 with the bailouts and Quantitative Easing. Unbelievable!

 Final Thoughts

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.

My top 3 reasons for why you should invest in physical gold today.

Why Should You Invest In Gold?


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15 Comments

  1. Great post, Marcus. I was lead to believe that gold was also worthless because in the days of old, that was the currency before we had paper money or other coins. I am unsure if I totally trust/believe economists, but I know I don’t trust what the bankers have to say. I have been researching other currencies to invest in, seeing as that the US dollar is not as ‘superior’ as we all once thought. I plan to research further. Enjoyed the article! 🙂

    • Hi Audra, thanks for reading.
      Yes gold has been the currency that we have used for almost 5000 years. It was only in 1971 that Richard Nixon basically took the whole world off the gold standard. That meant that there was no limit to how much the banks and governments could print. That is why we are now seeing the crazy amount of money printing that they do.

      I do not know much about currency investing but I would be very careful. You’re right that the US dollar is not as ‘superior’ as it once was. But there isn’t that many currencies in the world today that will keep their value if we get a currency crisis.

      Make sure that you really know what your doing before you invest in currencies or you can get wiped out just like the people investing in the US dollar will.

      Marcus

  2. Hello Marcus,
    very interesting article. Your chart about the gold price has a log scale, I think in a normal scale the difference would be much higher.
    The years before the financial crisis the central banks printed more money, according to the increasing supply in goods, but the value of the money diminished nevertheless. For me it is interesting, how they achieve their aim to keep the inflation rate low, but prices, especially asset prices, are rising and rising and despite their arguments and efforts the economy is not really growing rather we see one of the weakest growth after a recession. Therefore I agree, that you should buy some gold. It’s value remains stable over the centuries.

    • Hi Bernd. Yes your right it would be a bigger difference in a normal scale. This chart still gets me thinking. If you draw a trend line from the bottoms you can see that gold is going straight up over the long term.

      I do not believe in the numbers that the government puts out about inflation. They try to sell us this thing that there is no inflation. But they have changed the way they measure inflation so many times in order to make it look like there is no inflation. Anybody that goes to a grocery store or a gas station has noticed the big inflation.

      That’s why I don’t call their inflation number CPI as they do, I call it CP-lie 😉

      If they would measure inflation the same way as they did in 1980s we have around 5-6% inflation today. Check out John Williams at http://www.shadowstats.com/ for more information about that.

      Yeah it’s crazy how they still keep saying that we have a “recovery”. I mean since 2008 we have had 0% interest rates and all the QE that was suppose to help us with the recovery. Still there is nothing. But this is how they do things in Washington. They try to throw more debt at a debt problem and hope to solve it.

      Sooner than later people will realize that there is no recovery and that the FED will keep printing money. I think that’s when gold really takes off.

      Thanks for reading
      Marcus

  3. I liked this post.
    It presented as simple yet professional.
    The use of images (photos and charts) was both clever and useful.
    This post was informative and easy to read. The way the topics were separated was clean and easy on the eyes.
    I certainly know more about gold then I did before; worth the read.

    • Hi Roy

      Thanks a lot for the nice comment. I’m trying to simplify the economic situation and gold investing as much as I can. Lots of people are afraid of the term “economics” because they think you need 10 years on a Ivy league college to be able to talk about it. But it can actually be real simple if you just apply some common sense.

      Thanks for the read

      Marcus

  4. Hi there,

    Interesting article I came across. I’m also a little confused about it as I thought that the price of gold was going down. Is the situation reverting?

    Besides this, Gold is definitely a good storage of value. Never keep your savings in paper cash because inflation will reduce the real value of it.

    • Hi Kevin.

      The gold price was going down for about 2-3 years all the way until 2016. It has now reversed and it’s up almost 20% in 2016. It’s the best performing asset by far this year.

      I think gold just had a nice bear trap and now it will continue moving higher. Also we just got the facts this week from Deutsche Bank that the price of gold and silver has been manipulated. You can read about that here: http://www.bloomberg.com/news/articles/2016-04-13/

      Yes I agree and I’m not saying that people should invest all of their money into gold and silver. But at least 20% of their equity should be positioned in physical gold and silver.

      Thanks for the read

      Marcus

  5. Hey Marcus, nice website,

    I think you have something here. What america fails to realize is this natural resource will become relevant very soon. I also wanted to enlighten this paragraph:

    “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.”

    -This paragraph is key to the whole page. Investors, mentors or any financial literate person will tell you “gold will inflate, because the gov’t doesn’t want you to have access or be able to afford this natural resource. Money is such the perfect illusion to make one think they are rich, when in reality the printed money is valueless.

    feel free to shoot back feedback on my page,
    -MemeQueen

    • Hi MemeQueen

      That was a very good comment. And yes I agree with you that the “wealth” in paper is just an illusion. Because this paper wealth can disappear over night. Real wealth is tangible assets that has intrinsic value. Things like land, real estate and gold & silver.

      I think the strongest argument for gold today is the hedge against inflation. Our central bankers are doing everything in their power to keep this current system going by printing an enormous amount of money. This will create inflation and gold will inflate with the money creation.

      Thanks for your comment
      Marcus

  6. I completely agree that gold is probably the ‘gold standard’ for investing. You can’t go wrong with something that has been valued and lasts for thousands of years!

    Your explanation of inflation is great! I love the money on the island analogy.

    I would be curious what your thoughts are on silver compared to gold for the same investment purposes?

    • Hi thrivingcat. Yeah I think that every healthy portfolio should have at least 20% of their equity in physical gold.

      I really like to take complex wording and put it into a easy scenario to understand. Economics doesn’t have to be for the scientific people. It’s actually a lot of common sense. I’m glad you liked the analogy 🙂

      I think that silver has an ever higher potential than gold. They will both go up with inflation in the same way but I think silver is the most undervalued asset out there right now. There is almost no silver left in the world and every single piece of technology is using silver.

      I will be writing a post about silver in the future so keep posted for that. Silver is also easier to buy for regular people because it’s not as expensive as gold is. You can buy a ounce of silver for around $20 right now.

      Thanks for the read

      Marcus

  7. Thanks for the lesson on Gold and inflation. I did not think I was that uneducated. You sure did a great job of explaining inflation. Can you explain why they continue to print more money? It would have been nice to have heard your talk on hedging with gold when I was much younger.

    • Thanks for the comment Carroll. This is information that I wish the school system would teach us. But it feels like the people in charge wants the regular person to know as little as possible about the current economic system.

      If everybody knew what was going on I don’t think they could keep this system of debt going for long.

      The reason they print money is because they have to. The US government is about 1 trillion dollars in deficit every year. That extra money has to come from somewhere. So what they do is print more money. Basically paying of their MasterCard with their VISA.

      The US is bankrupt and as soon as the money printing stops that will be very clear.

      Thanks for the read

      Marcus

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