Inflation & Devaluation are Synonyms for the Same Process
In its various guises and different names, just as devaluation means a fall in the value of a currency, inflation means the increase in the price of most or all other products, services, and wages, etc. in terms of any currency.
According to Wikipedia:
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time.
Inflation's effects on an economy are various and can be simultaneously positive and negative. Negative effects of inflation include a decrease in the real value of money and other monetary items over time, uncertainty over future inflation may discourage investment and savings, and high inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Positive effects include ensuring central banks can adjust nominal interest rates (intended to mitigate recessions), and encouraging investment in non-monetary capital projects.
Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. Views on which factors determine low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities, as well as to growth in the money supply. However, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth.
Today, most mainstream economists favor a low, steady rate of inflation. Low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reduce the risk that a liquidity trap prevents monetary policy from stabilizing the economy. The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control the size of the money supply through the setting of interest rates, through open market operations, and through the setting of banking reserve requirements.
Increases in the quantity of money or in the overall money supply (or debasement of the means of exchange) have occurred in many different societies throughout history, changing with different forms of money used. For instance, when gold was used as currency, the government could collect gold coins, melt them down, mix them with other metals such as silver, copper or lead, and reissue them at the same nominal value. By diluting the gold with other metals, the government could issue more coins without also needing to increase the amount of gold used to make them. When the cost of each coin is lowered in this way, the government profits from an increase in seigniorage. This practice would increase the money supply but at the same time the relative value of each coin would be lowered. As the relative value of the coins becomes less, consumers would need to give more coins in exchange for the same goods and services as before. These goods and services would experience a price increase as the value of each coin is reduced.
From the second half of the 15th century to the first half of the 17th, Western Europe experienced a major inflationary cycle referred to as the "price revolution", with prices on average rising perhaps sixfold over 150 years. This was largely caused by the sudden influx of gold and silver from the New World into Habsburg Spain. The silver spread throughout a previously cash starved Europe, and caused widespread inflation. Demographic factors also contributed to upward pressure on prices, with European population growth after depopulation caused by the Black Death pandemic.
By the nineteenth century, economists categorized three separate factors that cause a rise or fall in the price of goods: a change in the value or resource costs of the good, a change in the price of money which then was usually a fluctuation in the commodity price of the metallic content in the currency, and currency depreciation resulting from an increased supply of currency relative to the quantity of redeemable metal backing the currency. Following the proliferation of private bank note currency printed during the American Civil War, the term "inflation" started to appear as a direct reference to the currency depreciation that occurred as the quantity of redeemable bank notes outstripped the quantity of metal available for their redemption. The term inflation then referred to the devaluation of the currency, and not to a rise in the price of goods.
This relationship between the over-supply of bank notes and a resulting depreciation in their value was noted by earlier classical economists such as David Hume and David Ricardo, who would go on to examine and debate to what effect a currency devaluation (later termed monetary inflation) has on the price of goods (later termed price inflation, and eventually just inflation).
The adoption of fiat currency (paper money) by many countries, from the 18th century onwards, made much larger variations in the supply of money possible. Since then, huge increases in the supply of paper money have taken place in a number of countries, producing hyperinflations-- episodes of extreme inflation rates much higher than those observed in earlier periods of commodity money. The hyperinflation suffered by the Weimar Republic of Germany is a notable example.
Effectively, during 2008, the pound sterling has devalued by a large amount.
Gauging the exact amount is almost impossible, because it depends what you measure its value against, but...
- US Dollars
In the earlier part of this year, the pound was worth over $2.00 US dollars. It is now worth less than $1.50; so has lost 25% of its value against the US dollar.
In late 2007, the pound was worth about €1.50; it is now about €1.05; so has fallen by about 30% against the euro.
On 1st January 2008, gold fixed at just under £425 per troy ounce. It has recently been around £530 per ounce. These figures reciprocate to 0.002353 ounces and 0.001887 ounces. To make this more easily understood, one pound was worth 7.3 grams, and is now only worth 5.9 grams, a depreciation of about 20%.
On 29th December 2008, both gold fixings were above £600 per ounce. We believe this is a clear sign of future prices.
Gold Price Movements are Relative to Currencies
Relative price motion explained by example.
Devaluation, Currency Depreciation, Inflation, Debasement
All four of these words are, to some degree, interchangeable. Debasement is more appropriate when applied to pre-fiat currencies, when coins were made of precious metal. This happened relatively recently in our history, less than 100 years ago. Coins were invented about 2,500 years before this.
The Wikipedia article does a fair job of explaining some of the differences between the remaining three words.
Whichever shade of meaning you decide to employ for which word, the overall effect is that the value of money declines.
We don't like to get too political, but...
Labour governments tend to expand the state sector of the economy by high spending and increased taxation to pay for it. Conservative governments tend to reduce the state sector budget (spending less), and can therefore afford to reduce taxation. We are not surprised then, that our current government has allowed or (mis)managed our currency to depreciate in value, although this has been done by stealth rather than public announcement.
George Osborne recently produced strong government criticism when he stated that the huge costs of bailing out banks, other financial institutions, and the economy in general, could create a run on the pound, similar to a run on a bank such as Northern Rock. This is a point we have worried about for several months now. When does the government of a country run out of confidence in its ability to back failing institutions, and suffer from a severe withdrawal of confidence. It is not an actual shortage of cash which causes a bank run, more the fear that it will run out of cash, a loss of confidence.
There have already been discussions about the ability of a number of countries to maintain a substantial value to their currencies, and to maintain liquidity. The IMF has become necessary and active once more. Britain had to be bailed out some decades ago, will it happen again, and when?
What About the USA?
So far, the US dollar has, to much surprise, benefitted from the credit crisis, the recession, and hot money flows. From statistics we have read, the recent American governments have put more dollars into existence than ever before, and by large factors. By any normal logic, the value of each dollar should be worth far less than it is (think about shares in a company). We believe that at some point, and not too far into the future, the value of the dollar must fall sharply. Which other currencies will gain we do not know, but we believe that one of the soundest measures of value is precious metal, particularly gold. We saw a news article recently quoting a Citibank expert as saying gold would reach $2,000 per ounce. We intent to comment on this on a forthcoming page.
Why This Page?
We created this page to explain inflation, and its effect on prices of gold bullion, gold coins, and other precious metals.
New Gold Forecast
These are all based on London Gold Fix prices.
We tend to be reluctant to forecast future gold prices, but do try to comment on matters which may affect them. Any significant change in the exchange rate of one currency is almost certain to strongly influence the value of any commodity measured in that currency.
Because the pound sterling has recently dropped by about 20% - 25%, then we need to revise some of our previous thinking about gold prices.
It is worth looking at our record high gold prices, which we publish in three different currencies:
The highest fix in pounds sterling was £542.810 on the morning of the 10th October 2008. At the time gold was "only" $918. The dollar sterling exchange rate was therefore $1.69 = £1.
Today (3rd December 2008) the afternoon fix for gold was $766.25 and £519.280, giving the exchange rate of $1.4756; if gold were to return to its 10th October dollar price of $918 at this same exchange rate, this would make gold £622.12!
Further, if we take the record highest price in dollars, $1,023.50 on the morning of 17th March 2008, at today's sterling exchange rate, gold would be £693.62!
If you believe the forecast of the Citibank's expert for gold to hit $2,000; this would put gold at £1,355.38 per ounce.
We hope this page has been useful. You may wish to see some of the other advice and information pages on our website:-
Very simple advice about investing in gold.
What form of physical gold to buy.
Gold Prices Index
Bullion Coin Selector Page