Don’t count on gold in a downturn

The way the price of gold keeps rising, a person might think that no matter what the downturn, gold would prove to be a good investment. I think that if things don’t fall apart too much, gold will be an OK investment. If things really start falling apart, though, it is not clear that gold will work nearly as well, especially if we expect gold to function as a currency itself.

If things don’t fall apart too much

If we keep teetering on the edge, but our current financial system remains in place, gold seems likely to be a good investment–whether it is coins or gold bars, gold shares or exchange traded funds. People are frightened, and because of this, seem likely to keep bidding up the price of gold for some time to come.

If our system flounders for a while and then recovers, gold should be at least an OK investment. The price of gold under such a scenario is likely to go up during the period of distress, and then come back down, as the distress leaves. An investor might do really well if he sells at the high point, before it goes back down.

Part of what makes gold look like a good investment now is that the alternatives look so bad. Almost any paper investment is exposed to the possibility of decline in value related to recession and increased debt default, and recession appears to be just around the corner.* People sometimes think of gold as an inflation/deflation hedge, and it is possible it will fill that role this time around as well, if everything stays together (except for the inflation or deflation).  The risk at this time would seem to be deflation, especially in stock and bond values, and in paper investments of all sorts. Gold has a reputation for being a good hedge against deflation, because its value held up well during the Great Depression.

If somehow, the country goes back on the gold standard in the midst of all of its problems  (very unlikely, it would seem), then the gold might really be worth a lot, especially if government doesn’t confiscate privately owned gold.

But what if things truly fall apart?

If things fall apart enough that banks close, and we don’t have our current financial system, then we really need gold to act as a substitute financial system. I don’t think it will work very well for this purpose, though.

For one thing, most things we want to buy on a daily basis are small things–a loaf of bread, some water, or perhaps a bicycle. Even if we had some gold coins, they likely wouldn’t work well for this purpose, unless there was a convenient way of making change. Silver coins would seem to be much lot better in this regard–at least the value of a coin might be somewhere closer to the range of what you might want to buy. A one-ounce gold coin that is worth nearly $2000 would be hard to trade for most things. Even a 1/10 of an ounce coin (worth close to $200) would be out of the range of many things you might want to buy.

The government could theoretically make certificates for a portion of a gold coin–but that would imply a better-functioning government than I expect will be the case. If the country isn’t on a gold standard (or gold-silver standard), it is hard to see that the government will issue certificates for a portion of a gold coin. An entrepreneur might issue such certificates, but then a person would have to trust that entrepreneur. Does the entrepreneur really have gold coins backing up his certificates, or is this just a scam? I understand that this is the way fractional reserve banking got started.

Gold coins would additionally have the problem of being easy to steal. Once a thief sees a buyer trade one gold coin for some kind of goods or services, there is the temptation to follow the buyer home to steal however many more coins might be there.

Counterfeit coins could be an issue too. Given the relative rarity of the coins, people wouldn’t see them on a day-to-day basis, and might not know exactly what they should look like, especially if there are several types of coins in circulation, some issued by different countries. Counterfeiting using gold plating or a lower percentage of gold would seem to be a possibility as well.

Gold bars would seem to be even harder to trade than gold coins. The buyer would have to believe that the bar is really gold, so some type of evaluation of each bar would need to done. People qualified to do this will not live on every corner, so both the potential buyer and seller may have to take a trip to get a suitable analysis performed. Or maybe a shortcut could be made for this process–but one can see why coins have been so popular in the first place.

Certificates for gold bars locked up somewhere or for gold mining stocks would seem to be even more problematic than gold bars. If the “regular” financial system isn’t functioning, it might not be possible to sell them.  If the bar is really there, and can be retrieved on demand and the gold mine is in fact still operating, then the shares of the company may have value, but it will be difficult to trade the “paper gold” for what you want.

If the paper gold is simply an ETF without any physical gold behind it, then the shares will disappear if the company issuing those shares goes out of business. Even when physical gold is involved, there would seem to be higher risk that something will go wrong, and the gold backing up the “paper gold” really isn’t there. Even a long-term electrical outage could be a problem, especially if all of the ownership records are electronic.

Gold may be useful in a few specialized instances–if a person needs to bribe a border guard, to let the person across a closed border, or to try to obtain medical treatment that is not otherwise available, for example. In such instances, a person would be close to desperate, and gold would seem to have as good a chance as anything as working. So as a back-up for occasional desperate situations, gold might work  fairly well.

Alternatives to gold

What options are there for investment, other than gold, that might do better in truly desperate times? It would seem like anything that could help you function better for the long term in the new economy that might arise after the failure of the current financial system would be better. Investment in skills that might help you in the new economy, or in land or equipment that might help you work the land might be helpful. Investment in moving back closer to family might be helpful, for people who would feel better with the support of, say, their adult children.

We seem to be entering truly unusual times. If one system fails, what we truly need is an alternative system to take its place–complete with new government, new currency, new land ownership rules, and a change in the way things are done to match the new reality of very little fossil fuels and much less long-term wealth.  If there are ways we could figure out these things in advance, it would be great, but it is hard for us to even think in these terms.


*The current financial system needs growth, and without economic growth, it will collapse from debt defaults. I have written that I believe that there is an underlying reason for this lack of growth–it is that the world is running out of cheap oil. We have plenty of expensive oil, but the without cheap oil, we quickly hit recession, and it becomes much more difficult to repay debt. The debt problems tend to accumulated in the government sector, because their tax revenue drops at the same time their expenditures for unemployment benefits and bailouts sky rocket. This Money as Debt video explains some issues related to the financial system’s need for growth.

About Gail Tverberg

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121 Responses to Don’t count on gold in a downturn

  1. markbc says:

    I don’t see holding gold as a way to buy things during the upcoming hyperinflationary depression. It is for the long term when a new monetary system is established, in some quasi-stable world. You can be certain that gold will be MUCH more valuable than it is today. Since there is many times less silver available now than gold, I see silver becoming even more valuable than gold potentially because it is used industrially for many many applications.

    To buy things during the monetary collapse, dried food will be the best currency.

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  3. Jvp says:

    Dear Gail
    I watched Money as Debt twice and found it very informative as well as your postings, so thank you in advance.
    I have a question about fractional reserves:
    As explained in the video the same money can get lent out over and over again in smaller amounts depending on an arbitrary ratio.

    My question is what happens if the money from the buyers Loan is then used to pay off the sellers debts rather than being deposited.

    I guess we are still left with the overhang of interest but isn’t this also what happens in the real world?

    I just worry that such simple explanations can add to the confusion of our predicament by painting an exapme that is too narrow.

    Thanks in advance

    • The money situation is more complicated that what the little video shows. For example, businesses don’t necessarily take out debt just because it is offered–a business needs to have a reason to expand, for example. So it is hard to make fraction reserving work exactly as planned.

      In response to your question, there is usually of long chain of payments involved when a loan is paid out. For example, I take out an auto loan, and buy a car. The auto dealership deposits that check in the bank, and then pays its various obligations–salary of the salesman, rent on the building, cost of the car from its supplier, and then these people in turn pay their various obligations. So there is a whole chain of bank deposits going on, not just in one bank. It is more the sum of all of the deposits that grows, as the loan injects additional money into the system.

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