Why Has Gold Gained The Title Of Best Inflation Hedge

The inflation hedging qualities of gold constitute one of the most popular beliefs of investors in modern times

. After so many years from the fall of the gold standard in 1972, people still think with nostalgia about the times when gold was used as money and back-up for all transitions made in paper money. As such, modern investors still look upon the yellow metal as the ultimate refuge in times of economic downturn and point to it as the only real instrument which can protect against inflation - the curse of all fiat-money based economies. But is this title of best inflation hedger a deserved one? And where did it spring from?

The first part of the answer has several sides to it. First of all, there is the tradition of gold being used as money, which lasted for a very long time in most parts of the world with developed economic systems, and which, after the rise of fiat currencies, strongly influenced the perception of gold as the ultimate and true value on the market. Money used to be made of gold, due to the fact that the yellow metal was and still is perceived as possessing inherent value. This tradition lasted until late in the 20th century, allowing various fiat currencies to be exchanged in their gold equivalent. The economic science, however, states clearly that no economic good has an intrinsic value, but only the value gained through economic exchange, circulation and rarity. This also applies to gold.

To actually see weather gold constitutes a hedge against inflation we need to turn to figures. Figures have been quoted a lot after the demise of the Breton Wood system to argue the pros and cons of the gold standard, with the inflation-hedging role of gold as one of the central questions. In spite of figures floating on the market, there are few thorough researches on this topic. One of the most documented is the "Golden Constant" book by Roy W. Jastram, which compares the value of gold and that of the main commodities traded in the British Empire and the United States for a period of 416 years. Based on these figures, the book demonstrates the theory that the value of gold is appreciating rather in deflationary economic environments, and not in inflationary ones, such are the economic conditions after the demise of the golden standard and the rise of fiat currencies.

The book admits however, that gold does provide some protection against inflation, inasmuch as by inflation we understand a decrease of purchasing power and a temporary rise in prices.

However, is we accept the economically correct definition of inflation - an increase of monetary mass and credit without coverage in goods or services - and compare its evolution with the price of gold, the conclusion becomes evident: monetary mass increases much faster compared to the value of gold, which demonstrates that gold does not constitute an efficient long term protection against inflation.

by: Jack Wogan.

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