Many financial commentators, including the usually on-the-spot Mish Shedlock, have been saying for quite some time that gold will go up in a deflationary environment. Their argument is that gold is money and money does well in deflation. I would be willing to wager that Mish has more understanding of economics while half asleep than I will ever hope to have, and so I assume he’s just being simplistic and inprecise with his words. However, people then repeat it often enough, and it takes on a life of its own. There are many people explicitly claiming that the price of gold should rise during both deflation and inflation. Empirical evidence to the contrary gets brushed aside by either (a) claims that the gold paper market (COMEX) is being manipulated or (b) we’re in a temporary period of gold falling due to hedge fund deleveraging.

However, straightforward logic will tell you that gold should not neccesarily go up in price during deflation. Yes, it’s money, but so are dollars! And since gold is always priced in units of somebody’s money, why should it always go up? Sure, it will increase in value, relative to other assets, during deflation, but without other factors to consider there is no reason to expect it will increase in price. After all, the Yen is money, so shouldn’t it go up during deflation? Obviously, every currency cannot go up relative to every other currency, and so, too, the price of gold will not automatically go up during deflation.

So the real question is this: is gold an attractive currency relative to the dollar? I’d argue it depends on the stuation. If you expect the deflation to be caused by lower demand for goods despite an increase in the money supply, you might consider gold a more stable value. But there are inherent disadvantages to gold, such that all things being equal, cash wins: You can’t pay debts with gold, and none of your future expenses are priced in units of ounces of the stuff. There’s no way to make gold disappear, but in our fractional reserve system, fiat currency can vanish during a period of debt destruction. If I were confident of such a monetary deflation persisting I’d personally want to keep my wealth in the ever scarcer fiat currency, not a form of money that’s dug out of the ground and hoarded by metric tons in central bank vaults around the world.

I certainly agree that it’s possible for gold to go up during deflation, and that if ever there were a situation where it should, it’s perhaps now. All I’m saying is that the idea that gold will always go up during deflation is as nonsensical and meaningless as saying the Euro will always go up during deflation. It depends on the situation. I think the best argument for holding gold during a period of deflation is simply the expectation that the government will soon do everything in its considerable power to reinflate the currency.

(Disclaimer: Lest anyone think I’m the typical antigold zealot sniping at the bugs, I’m actually long a significant portion of my meager grad student portfolio in GG and DGP.)