Why to Buy Gold in a Deflationary Economy

08/31/11 Poitou, France – The Dow rose 20 points yesterday…after a fabulous increase the day before.

Gold went up $38.

We’ve already given you our forecast. We think gold AND stocks are going down. But what do we know?

The role of markets is to make fools out of market analysts. So, the shrewd forecaster has to be careful. He shouldn’t be too precise in his predictions. He can say what direction prices are going. Or he can say when. But not both.

If we tell you that ‘stocks are going up,’ we’re sure to be proven right — if we wait long enough!

Likewise, if we say ‘you’ll see gold hit a high this autumn’ we leave ourselves plenty of slack to shape events to fit our forecast. It’s bound to hit some kind of high during that period.

But here at The Daily Reckoning, we have no reason to hedge. No reason to wiggle and slide. You don’t pay for this subscription: you get what you pay for!

For 11 years we’ve told dear readers to ‘buy gold; it’s going up.’ This was good advice. Gold did go up…more than any other asset.

Now, what are we saying? We’re still urging readers to buy gold. Gold is the only true money. It’s been used as money for thousands of years. And it will probably be used for thousands more. At least, we have a strong hunch it will be used when today’s claptrap money system blows up.

Still, the system may surprise us…like an old refrigerator, it may last a lot longer than we think it should.

Did we explain why? Well….here’s the explanation again:

We’re in a Great Correction. Recently, this correction has given every indication of hanging around for a long time — a la Japan.

We’re also in a period when the feds are throwing caution to the winds in order to over-turn the correction. But, here’s what has happened: the feds have not been able to do it. They’ve tossed a lot of caution to the winds already. But the winds don’t care; the correction continues. Just read the headlines. Consumer sentiment is sinking. House prices are still going down. The number of people on food stamps is going up.

This is fundamentally a deflationary economy. It’s not an inflationary economy. It’s not an economy that will take up the Fed’s EZ money and transform it into consumer demand. It’s not an economy that will borrow money from the banks and increase employment and the money supply. The feds have been unable to ignite the kind of ‘animal spirits’ you need in order to get inflation rates up. They’ve tried everything. It hasn’t worked.

No, it’s an economy where demand is falling. We saw that yesterday. Gasoline use in the US has dropped to an 8-year low. Households are saving money. Incomes are going down. The real economy is shrinking.

At the household level, thrift is on the rise. Among the investoriat, fear is the dominant emotion. This stock market could collapse any day; all it needs is the right headline.

The Fed has been forced to tell the world that it will keep its key lending rate at zero for two years. This is an admission that nothing has worked in the fight against the Great Correction. It is a clear signal that the US will follow Japan down that long, lonesome highway…towards a multi-decade slump. The US has already had one ‘lost decade.’ Most likely, it will now lose another one. For now, the feds have been beat.

The victory of fear over greed means that investors are no longer concerned with the return ON their money; they’re worried about the return OF their money. And they think that the safest place for their money is in US Treasury debt. Lend money to the people who print it; what could go wrong?

Well…that’s what we’ll find out when this current stage of Great Correction/de-leveraging comes to an end.

When? How? We don’t know.

But NB…we don’t really know what is coming. So, we try to figure out what we think you should BELIEVE is coming. And right now, there’s a lot of risk in stocks…and in bonds. And in the short term, there’s risk in gold too.

You’re probably best off believing that stocks will go down….gold will go down…and that the economy will remain in a period of fear/demand destruction for months, and probably years, before a major corner is turned.

In the meantime, stick with gold (as insurance) and cash (as ammunition).

At least that way, if the price of gold goes up…you’ll feel rich. If it goes down, you’ll feel smart. And then you can use your cash to buy more gold.

Bill Bonner
for The Daily Reckoning