Home > Macro/Monetary Theory > A Bit of Finance

A Bit of Finance

Here is a concrete way in which the Austrians are confused.  They think when the economy collapses, that the stock market will go down and gold and silver will go up.  This is because they think the threat to the economy is hyperinflation.  When you see those gold commercials on TV they always talk about using gold to diversify your portfolio.  I get the feeling most people don’t really know what this means because I once saw Shepard Smith going off about how gold is not safe as though he thought that people think that gold is just inherently safer than other investments.  But that’s not the point.  Traditionally, gold is a hedge.  To put it simply, this means that gold goes up when other things, like the stock market, go down and vice versa.  Because of this if you hold both gold and stocks then you are less likely to suffer a large loss because large drops in one asset are usually offset by large gains in the other.

So if you buy into this logic, and you think a stock market crash is coming, it makes sense to invest in gold, not only as a hedge, but as a bet against the stock market.  But if you have been following the markets on a more-or-less daily basis as I have, then you may have noticed that these two things no longer move in opposite directions.  For some time (like 6 months to a year) when the stock market has gone up gold has gone up and when the stock market has gone down gold has gone down.  Unfortunately this is only a casual observation I don’t have data to show you but look into it, it’s true.

So why is this happening?  Gold and stocks are different in that they appeal to opposite attitudes about the real economy.  When people are optimistic about the real economy they buy stocks because they expect them to grow rapidly in real value.  When they are pessimistic, they buy gold because they figure gold won’t completely evaporate in real value like stocks are prone to do.  So they tend to move in opposite directions due to real shocks.  But gold and stocks have something in common.  They are both real goods.  Which means they are both subject to monetary shocks in the same way.  When the price level goes up, they both go down.  when the price level goes down they both go up.  So what we are seeing now is a real economy which is fluctuating mainly due to monetary shocks not real shocks.  This means that gold and stocks are no longer hedges for each other.  Inflation helps both but more importantly, deflation–which is what we should be worried about–kills both.  Think about this before you put all your money in gold.

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Categories: Macro/Monetary Theory Tags: ,
  1. February 6, 2013 at 11:51 am

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