Why hold gold in deflation?

December 23, 2011
Santiago, Chile

First off, happy holidays. I hope this email finds you in good health and cheer.

Down here in Chile, I intend to spend the weekend (and most of next week) doing absolutely nothing but reading, relaxing, and riding horseback with friends around our new 1,000+ acre farm. I’m excited that many readers will soon be joining me.

Personally I’m not much for the holidays. The last two months of the year (starting with Halloween) feel a lot more like forced consumerism– people buying useless trinkets with money they don’t have for the sake of others they hardly know, or for close friends who simply don’t care.

I prefer to opt-out of the whole nonsense and simply tell the people I care about that they’re important to me. On that note, I’m truly grateful for our daily conversations and the many wonderful relationships that this letter has brought.

2012 will undoubtedly be a difficult and challenging year for the global economy. But I can promise you that the world is not coming to an end. The game is simply being reset with a new set of rules.  And whether young or old, rich or poor, the decisive, creative mind will thrive.

It’s overwhelming to see how many people are waking up to reality, educating themselves, and taking action. And I’m truly humbled to play a part in this movement. Thank you for being a reader, and I look forward to our continued conversations.

With that, a few questions from this week:

Tom Childs writes, “Simon, regarding Chile, what are your thoughts about the very considerable risk of burgeoning volcanic activity in the country? Is your retreat in any way threatened by an expanded volcanic crisis?”

Quite frankly, volcanic activity in Chile is actually Argentina’s problem.

The prevailing Pacific winds blow to the east, picking up ash and dumping it on neighboring towns in Argentina. During the last minor eruption, ash was swept as far east as Uruguay.

I wouldn’t want to be at the foot of a volcano, in Chile or anywhere else. Our farm, however, is more than a safe distance away. We have great views of some volcanoes and snow-capped Andean peaks… but I have zero concern of seeing any lava in my living room.

Next, in response to my comments about weaknesses in the banking system, Patrick writes, “Simon, while the US government may be bankrupt, they will just print more money to cover any FDIC insured assets if a major bank went under. More than likely they wouldn’t even let it go under.”

At this point, the FDIC’s insurance fund is woefully undercapitalized. Meanwhile, banks are sitting on nearly incalculable losses (real and nominal) for having accumulated so much worthless paper.

Some people may take comfort that the US government will bail out depositors by printing more money… that the deposit risk in the US banking system is negligible because Bernanke will simply conjure more money out of thin air. I’m not one of these people.

To me, a bank is safe because it is profitable (not because of clever accounting tricks) AND well-capitalized. False promises and guarantees of monopoly money provide me no sense of confidence.

What’s more, for individuals with a higher net worth, the insolvent FDIC can only guarantee up to $250,000 anyhow. So fundamentally, the central issue falls back on a bank’s creditworthiness. I’m not willing to take that chance with US banks.

Last, Stefan asks, “Simon, you mentioned that you’re investing in precious metals… suggesting that you hold a consensus view that inflation is what we’re in store for. What if the crisis actually produces the opposite effect– deflation– and the value of precious metals falls?”

Deflation certainly is a possibility. I’m not squarely in one camp or the other… I look at the totality of circumstances, and in my travels around the world (I hit over 40 countries this year), I objectively look for signs of both.

At the moment, I see far more signs of -inflation-, but that’s because I’ve spent my time this year in many developing nations where the US exports inflation.

Here’s the thing– if the debt bubble bursts and many of these insolvent countries do default (which is quite likely), it could cause a massive deflationary chain reaction in which the price of gold drops dramatically.

Whether any potential deflationary effects are short-lived (like 2008) or long-term (Japan), I still want to own gold. Along with a debt-bubble bursting will come a severe loss of confidence in the fiat system… and gold is a great hedge in this scenario.

More on that soon. I hope you have a great and restful holiday period. Best wishes from all of us to you and your family.