I am asked constantly how gold would perform in a deflationary collapse. With the propensity of the Fed and the ECB to flood the system with liquidity and to take "extraordinary measures" whenever problems arise, deflation is a remote possibility for the foreseeable future. So, before worrying about deflation, I would worry inflation accelerating strongly in the years to come - especially if the US economy stagnates. But let us assume that at some point in the future deflation follows. What then? In my opinion, deflation could only be triggered by one event: a total collapse of the existing global credit bubble. And the only event that I can think of that would trigger such a debt collapse would be a third world war. The failure of a large bank - say, Citigroup - wouldn't do the trick, because the Fed would immediately bail it out (unless Ron Paul is US President).
Now in a debt collapse, where would you rather have your money? In bank deposits, in CDs, in dubious commercial paper, in bonds, in money market funds - all of which would experience soaring default rates - or in physical gold, ideally in a safe deposit box? I think that, particularly in a debt collapse, physical gold would shine, as people the world over would become extremely concerned about, not the return on their money (interest), but the return of their money. This would be particularly true of Asian central banks, which now have less than 2% of their reserves in gold but hold massive quantities of all kind of debt securities.
Consequently, while I find the gold price to be currently somewhat overbought, I still think that gold will be one of the best investments over the next couple of years. In particular, I would expect demand for gold from individuals around the world to increase meaningfully - especially in Asia - at a time when production is unlikely to increase. I wish to add that I am not a "gold bug". I would much prefer to live in a world in which central banks' top priority was to safeguard paper money's purchasing power and its function as a "store of value". I would also much rather live in a world in which the US dollar was a strong currency, and where America was as free as it was in the 1960s, and the economic and financial imbalances weren't as extreme as they are today. As Steven Roach recently remarked, "no nation has ever devalued its way into prosperity". But the fact is, the time has come when we can no longer trust central banks. Therefore, each individual must be his own central bank and maintain adequate reserves for himself in the form of physical gold. The supply of paper money is potentially endless, whereas the supply of gold is very limited. (In fact, gold production from mines is declining.)
Marc Faber
excerpted from
The Gloom, Boom & Doom Report - Nov 2007
