The U.S. economy, specifically the U.S. dollar, is at a crossroads now that the Federal Reserve Bank’s unprecedented “Quantitative Easing” policy is gradually being cut back.

The series of QE moves involved various methods of expanding the Fed’s balance sheet by printing over $3 trillion of new dollar money since the latest financial crisis, which began in 2008.

The two signposts at the “crossroads” are labeled “INFLATION” and “DEFLATION.”

As we examine the consequences of going down either of these roads, we find that holding gold bullion in a portfolio can make the trip much more survivable.

Deflation Road
The reason that the Fed began this massive money printing was to stave off a severe deflationary cycle. Deflation is the Fed’s greatest fear, because it the hardest condition to reverse. In a deflationary spiral, prices drop while the value of money increases. Spending and investment would dry up because the value of things that would be bought or invested in is dropping, which causes demand to be cut back, strangling economic growth. Debt, both government and private, becomes harder to repay, leading to defaults and bankruptcies.

Ben Bernanke, who headed the Federal Reserve during the start of the crisis, was a student of The Great Depression, the worst episode of deflation in U.S. history. The conclusion he came to from research was that deflation should have been combated with massive dollar printing; so, when faced with a similar problem, his theoretical solution was applied.

He gained the nickname “Helicopter Ben” for the analogy of his dropping loads of cash from helicopters. However, he and the other Fed governors were more concerned about stopping the deflationary spiral from beginning than dealing with any resulting inflation.

By and large, quantitative easing succeeded in avoiding deflation. But U.S. banks had been structurally damaged by the 2008 crisis, and they used the cash inflows from the Fed to purchase safer Treasury instruments to heal their balance sheets.

With the banks not lending to spur economic growth, there was no resulting inflation—just stalemate: no deflation, but no inflation.

The Fed may well have to continue combating the threat of deflation with continued money printing, but at some point this increasing of the Fed’s balance sheet will become unsustainable. 

Gold On The “Deflation” Road
James Rickards is an advisor on international economics and financial threats to the Department of Defense and the U.S. intelligence community, who served as facilitator of the first-ever financial war games conducted by the Pentagon. In his book, The Death of Money, he suggests that if the Fed’s continued easing fails to avoid deflation, “the only way to break deflation is for the United States to declare by executive order that gold’s price is, say, $7,000 per ounce, possibly higher … Deflation’s back can be broken when the dollar is devalued against gold, as occurred in 1933 when the United States revalued gold from $20.67 per ounce to $35.00 per ounce, a 41 percent devaluation. If the United States faces severe deflation again, the antidote of dollar devaluation against gold will be the same, because there is no other solution when printing money fails.”

Inflation Road
Fed policy has been designed to be inflationary, because the Fed’s governors believe they can handle inflation better than deflation.

The massive printing of money helped cause the price of gold to soar to a peak of $1,900 in 2011. But as noted above, the anticipated inflation never came.

However, all of those dollars floating around in the system may be put to a different use now that the banks’ balance sheets have been repaired. The inflation threat has not gone away -- its coming may have just been delayed. 

The Fed’s desire for introducing some inflation into the economy may be fulfilled, but as they say, “Be careful what you wish for.” Although the Fed may be confident that it can handle an inflationary spiral, it may not be as painless to control as hoped. “Real” inflation tends to lead to “inflation expectations,” a fear of future inflation that often defies policy countermeasures and becomes self-fulfilling.

Gold On “Inflation” ROAD
Gold’s historical role as a hedge against inflation was confirmed by a recent study of inflationary periods. From January 1, 1973 to June 30, 2013, gold proved to be the best performing asset class at 10.1% over Equities (7.0%), Treasury bonds (6.7%), Commodities (4.7%) and the Dollar (-0.5%). (Source: “The role of gold in investment portfolios,” Nov 2103, Flexible Plan Investments, Ltd.)

Whichever road the U.S. economy takes, “INFLATION” ROAD or “DEFLATION” ROAD, it seems that bringing along some gold will help make the journey more survivable.

Rick Andrews, president of Avant Capital Management LLC, located in Sarasota, Fla., is the creator of The Gold Bullion Strategy Fund (QGLDX) structure. There are two patents pending on the Fund’s structure and management process.