Executive Summary

· Deflation is defined as falling levels of both economic activity and falling price levels on an absolute
basis. The contraction of economic activity is generally preceded by an unsustainable boom period
and is usually kicked off by an event which causes economic confidence to be lost. Deteriorating credit
quality, the shift from capital growth to capital preservation, and the hoarding of capital are
characteristics of most deflationary periods. Deflations typically end after crisis conditions force
policymakers to enact large-scale inflationary policies designed to counteract deflationary conditions.

· In historic US deflations, individuals had the choice between paper currency or gold as hoarding
vehicles. The historical record demonstrates that loss of confidence in the issuer of paper currency is
often a sufficient reason for individuals to choose gold over paper currency. We attach a detailed review
of the behavior of gold under each US deflationary period since the Post-Jacksonian deflation of 1837-
1843.

· In a prospective deflation, the existence of large foreign exchange reserves and a historic accumulation
of financial assets means the magnitude of capital flowing to hoarding vehicles is large. With a limited
pool of hoarding vehicles in today’s marketplace, prices of scarce hoarding vehicles would be bid up.

· Compared to widely available cash-substitutes, gold’s relative attractiveness boils down to relative
credit quality. Competing against foreign currencies, the role of gold as a preferred hoarding vehicle
will depend if deflation is limited to the US or spreads internationally. Under the global deflation
scenario, foreign currencies would also be negatively impacted by deteriorating credit quality.

· Because of cultural conditioning, Americans may ignore gold as a currency alternative in the early
stages of deflation. Considering the importance of Asian investors to gold demand and the favorable
cultural conditioning Asian cultures have towards gold, this may be a mistake. Asian investors may
gravitate towards gold much earlier in a deflationary spiral, leaving American investors behind.