Claude Cormier wrote:
> A recipe for stagflation

why oh why do 'goldbugs' seemingly always seem to predict a large rise
in the price of gold in the medium term?

The price of gold in terms of US dollars has been enaything but stable
in the last few decades, whereas, the widespread (near universal) use of
USD in the $10 trillion US economy, makes the price of USD stable in
terms of goods and services, at least in the short term. 

Variable inflation of this currency attached to the economic giant makes
the price of gold, an inflation hedge, makes for wild changes in the
real price of gold, as expected inflation changes. The emergence of
inflation when nominal interest payments are heavily taxed, can easily
make the real return on savings less than zero, in which case savers
look for alternative stores of value. Combined with economic uncertinty
over the direction of stockmarkets and the real economy, and gold
becomes a very good investment, a stocks become risky and poor

This makes gold a poor currency for a small open economy to adopt, and
makes gold a poor unit of account, measure of value and store of value.
If gold were the general means of exchange in a large open economy or in
a closed economy, its performance as a unit of account, measure of value
and store of value would be much better. 

The adjustment required of a small open economy that adopted gold as
money  would be difficult and painful. If US inflation and inflation
fears were ignighted, the real exchange rate of the SOE would rise very
sharply, and require downward adjustment of wages and prices in the SOE.
This deflation would cause land and building prices to collapse. The
inflation and deflation in a SOE that used gold would be significant and
arbitrary, and cause asset prices in the SOE to be highly volitile. The
situation would be similar to SOE such as Hong Kong, where the currency
is fixed to the USD. Property prices fell by around 40% in 1998 in Hong
Kong as inflation turned to deflation. Unemployment rose from about 2%
to over 6%, real GDP fell by over 5%. By contrast Taiwan and Australia,
both highly exposed to the Asian Crisis, continued to register
significant growth and asset prices did not crash and unemployment did
not rise. This is largely because their nominal exchange rates fell,
reducing the need for adjustment and the extent to which sticky prices
cost output.

David Hillary

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