Is gold a hedge against inflation?

Steve Saville, one of my favorite commentators, addressed this question recently:

[U]nder the current system a high rate of monetary inflation is one of the two primary ingredients of a long-term gold bull market. Monetary inflation is not sufficient by itself, but when mixed with the second ingredient the result will be a powerful advance lasting many years.

The second ingredient is: enough economic weakness/problems to bring about a general increase in the desire to save. The economic problems cause both an increase in the desire to save and a reduction in the demand for growth-oriented investments such as equities, while a high rate of monetary inflation prompts people to save in terms of something other than the official currency.

Rather than saying that gold is a hedge against inflation it is therefore more correct to say that gold is a hedge against inflation under certain economic conditions. At other times, investments such as general equities could prove to be far better hedges against inflation.

Of course, Steve is not the only one to raise the question of gold as an inflation-hedge. Economics writer Robert Blumen wrote an article on the subject on March 6, 2007.

The problem with concluding anything based on the US$ price alone is that an analysis of US$ price of gold is as much an analysis of the US$ exchange rate against other fiat currencies as of the value of gold itself. The US$ exchange rate is affected by many political variables, including currency intervention by foreign central banks and the sometimes non-linear effects of the Fed’s inflation. Dollar inflation, working through what James Grant calls the "international monetary non-system" has in some periods had the paradoxical effect [of] driving up the value of the dollar against other currencies. During those periods, the dollar price of gold performs poorly, but the price in other currencies outperforms.

Relying extensively on the research of Paul van Eeden, Blumen says:

[W]hen the gold price is examined against a global weighted index of fiat currencies, it is rising approximately at the same rate as the purchasing power of fiat paper money is declining. Van Eeden’s data show that gold has done a good job maintaining purchasing power over time against fiat money inflation. In other words, gold functions as an inflation hedge. The market has priced it like other currencies on the international money markets.

Blumen adds:

As van Eeden explains, the poor performance of the US$ gold price during the 90s was primarily a reflection not of declining monetary significance of gold, but of the dollar’s overvaluation relative to other fiat currencies. The over-valuation of the dollar resulted from several factors: a massive asset bubble in the US; a series of currency crises fueled by debt implosions in the developing world; and the reluctance of Japanese central planners to allow the Yen to appreciate as they attempted to inflate their way out of the 15 years of doldrums following the collapse of their credit bubble in the 80s.

His conclusion:

The dollar price of gold can be flat or falling even when the quantity of dollars is increasing so long as the dollar exchange rate against other currencies rises. The non-buyer of gold, then, is speculating [on] an appreciating dollar exchange rate cancelling out the effect of currency debasement.