Why I Like to Invest in Gold

Investing in gold is controversial. The reason I prefer gold as an investment is that it is a reliable counter against inflation. Many argue that inflation is not a problem, especially during a recession, but I believe inflation can still be a problem during economic downturns. A second counter is that the federal reserve will not inflate. I believe that the FED will inflate. A third counter is that gold is not a good inflation hedge. While there are times in the recent past when gold did not perform well, I believe times have currently changed for the better for gold (and for the worse for our economy).

The first objection is that inflation is not a problem during a recession. The argument is that during an economic downturn, aggregate demand falls which puts downward pressure on prices. Empirical evidence points to falling prices during the Great Depression. To a certain extent I agree with this analysis. I believe that the overall level of prices is determined by the supply and demand for money. Let's assume that the supply of money is fixed. During a recession, private consumption falls and private savings increases. Part of the increase in savings constitutes physical money and thus during a recession the demand for money increases. An increase in the demand for money increases the value (or the price) of money which means that the price of everything else falls relative to money. Thus, I would agree that prices fall during a recession, assuming that the supply of money is constant.

The important premise is that the supply of money is constant. I do not believe that the government will stand idly by and keep the money supply constant while the economy falls into recession. Milton Friedman wrote that the Great Depression was caused because the FED allowed the money supply to fall, which reduced prices and the reduction in prices caused the economic downturn (I'll write another blog about this idea later). Thus, mainstream economists believe that expanding the money supply to offset the fall in prices helps an economy out of an economic downturn. The newly printed money can be used to buy things which stimulates aggregate demand. The increase in money supply can cause prices to stop falling, and if enough money is printed, to rise. The rise in prices is expected to help the economy by reducing the demand for money which will increase the demand for goods and services. Also, there is a belief among economists that a weak currency helps economic growth by stimulating exports and reducing imports. In my other blog (economyandpolicyreport.blogspot.com) I have written against this idea, but it is generally held.