All Things Gold – Government Default Could Mean A Lower Gold Price

Analyst, Author, and Owner of Kelsey's Gold Facts
November 13, 2023

ALL THINGS GOLD

In the world of “all things gold”, every event is viewed within the context of how it will affect gold prices – on the upside.

Earlier this year, it was bank failures. Before that and since then, the focus was/is on the Fed with regards to a possible reduction of interest rates.

Two years ago, it was Russia vs Ukraine. Last month, it was Hamas vs Israel (see Gold Price And Geopolitical Concerns).

Even on a weekly basis, there is continual focus on various economic statistics, even though the topics (housing starts, (un)employment, recession, etc.) have nothing to do with the gold price.

Now, a potential government default is on the table again.  Time to debunk another myth about gold and resultant price expectations.

PROSPECTS FOR GOVERNMENT DEFAULT

It’s trite, yes; but the chances of an actual debt default by the U.S. government are slim and none.

A debt default is only a topic of consideration due to political games and grandstanding. There is a “legal” debt limit for the U.S. government but it has no practical application.

Regardless of what various members (both political parties) of Congress say, none of them would be willing to answer the questions of their constituents should they be viewed as responsible for the widespread negative consequences of government debt default.

That being said, even in the event of a “default”, and amidst all of the potential negative consequences resulting therefrom, there is ample fundamental support for a lower gold price – not a higher one.

LOWER GOLD PRICE 

The current concern about default is because of the legal debt limit imposed by law on the government.

Having reached it’s borrowing limit,  the U.S. Treasury cannot issue additional new bonds to retire bonds that have reached their maturity date. Also, there would be no cash proceeds from additional new bond sales for the government to pay their bills and continue operating.

The issuance of new bonds is how the government creates inflation – by expanding the. supply of money and credit. The expansion of money and credit cheapens the value of all the money in circulation.

As a result, all of the existing money loses purchasing power. The loss of purchasing power shows up as higher prices, which are the effects of inflation.

When you think logically, it seems clear that if the government is unable to issue new bonds to refinance its existing obligations and get additional proceeds to fund its ongoing operations, the result is deflation; the opposite of inflation.

We are already experiencing a destruction in the supply of money and credit as financial assets decline in price and the effects of higher interest rates weaken economic activity.

A debt default by the government would expand and accelerate the deflationary process and could plunge us into a depression.

Deflation, being the exact opposite of inflation, means that your dollars would buy more (a gain in purchasing power), not less. The bad part is that there would be fewer dollars to go around.

Since a higher gold price over time is the result of the loss of purchasing power in the U.S. dollar, and since deflation results in a gain in dollar purchasing power, there is no fundamental reason to expect a higher price for gold under deflation.

Since there is no fundamental reason to expect a higher gold price during deflation, and since a debt default by the U.S. government is deflationary, there is no fundamental support for expectations of a higher gold price resulting from debt default by the U.S. government.

CONCLUSION 

I am not predicting deflation, nor do I think a debt default by the government is imminent.

My intention is to call attention to the unreasonable expectations and predictions for a higher gold price that are based on circumstances and events that have nothing to do with gold; or, in the case of government debt default, the fundamentals are contrary to the expectations.

The only fundamental reason to expect a higher gold price is to reflect any additional loss of purchasing power in the U.S. dollar.

Nevertheless, gold is slow in recognizing those losses and tends to react to them after the fact. Sometimes years after the fact. (also see Effect Of Deflation On The Gold Price)

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED!

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Kelsey Williams has more than forty years experience in the financial services industry, including fourteen years as a full-service financial planner. His website, Kelsey's Gold Facts, contains self-authored articles written for the purpose of educating and informing others about gold within a historical context. In addition to gold, he writes about inflation and the Federal Reserve.

Kelsey is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN'T, AND WHO'S RESPONSIBLE FOR IT and ALL HAIL THE FED! 

Kelsey Williams is available for private consultations, public speaking, and interviews at [email protected]


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