Why governments love inflation and you should love gold

published 15 September 2010

Two years ago, Lehman Brothers went bankrupt. Today the authorities would have you believe that the financial crisis is all but behind us.

Sure, the 'recovery' may be faltering a little, but that's just a temporary thing: give it a couple of months and all will be well.

Believe that? I don't think we do. And one quick look at the gold price should tell you that not very many other people do either...

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What's worrying gold?

Yesterday gold hit an all-time high in dollar terms $1,274.30 an ounce. Given that ten years ago not many people expected the price to ever hit even $500 again, that's quite a thing.

So what's gold worried about? Currencies. There has been a good correlation between worries over sovereign debt in Europe (as expressed by the rising yields on debt issued by the 'peripheral' countries yields rise as prices fall) and the gold price. This subject might have fought its way off the front pages, but is still lurking nastily in the background. The euro is just as much at risk as it was six months ago.

But it isn't just the euro that is bothering gold: it is the general race for the bottom among all currencies. The dollar has been on the slide recently (which of course partly explains the new high in the dollar gold price) but the Bank of Japan has now started intervening to get the yen down too. It has just sold something in the region of 300-500bn (£2.3bn to £3.9bn) worth in its efforts, reports Reuters.

That's worth noting simply because it is their first intervention since 2004. The Bank has clearly finally had enough of the strong yen stifling whatever recovery might be lurking behind the dismal economic data. The Japanese stock market surged as exporters applauded the move.

Watch out for deflation

But gold isn't just looking for today's currency degradations: it is also watching for the deflation that will bring more of them. There isn't much obvious sign of it about I've noted on our blog before that if you calculate US Consumer Price Index (CPI) inflation using European methods it isn't much lower than UK CPI (currently 3.1%).

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But regardless of the immediate evidence, the prevailing opinion is now much biased towards deflation. We are constantly told that all the things keeping our numbers above target are temporary influences, which in a matter of months will be cleansed from the data. Perhaps they are (although with commodity prices rising at speed it isn't exactly a given). But if there is one thing gold knows, it is that nothing brings inflation along faster than the fear of deflation: Why deflation is good for gold prices.

There's more money printing to come

Banks and governments hate stable prices. Without inflation they can't get on with their general work of favouring borrowers over savers and cutting the real wages of the population in the name of competition. So the very idea that the CPI might fall below 2% is enough to prompt massive intervention. There's bound to be more quantitative easing (QE) to come. And that, as the gold price is desperately trying to point out, will almost inevitably undermine currencies and leave us with very high inflation.

All this means that we should hang on to our gold: as all governments work to erode the value of their own currencies via inflation or outright intervention it is still pretty much the only safe place to be. You can find out more about investing in gold here.

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Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.