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Gold And Interest Rates - A Mass Of Confusion

Gold And Interest Rates - A Mass Of Confusion

Over the past several months there have been numerous articles referencing a relationship between gold and interest rates. Most of them are well-meaning attempts to convey information about recent changes in the markets as interest rates head higher.

In several instances, however, the author(s) have tried to explain a 'perceived' correlation between rising interest rates and the value of the US dollar - in a very positive manner. And they have imputed a similar correlation - albeit negative - in other statements with respect to Gold. In both cases they are incorrect.=

"Higher rates boost the value of the dollar by making U.S. assets more attractive to investors seeking yield." ...WSJ 4JAN2017

The higher rates might be attractive temporarily to investors seeking yield but they do nothing to "boost the value of the dollar". In fact, historically speaking, the higher the interest rate, the more suspect is the value of the dollar (or any other currency - for example, the Mexican Peso 1982).

Between 1971 and 1980, interest rates in the U.S. climbed to mind-numbing levels. The benchmark 10-year Treasury Bond sported a whopping yield on the north side of 15%! The higher rates did nothing to boost the value of the dollar. In fact, during the entire period, the value of the US dollar plummeted. This was reflected accurately in the US dollar price of Gold which rose from $45 per ounce to $850 per ounce - a nineteen fold increase.

"Because gold doesn't bear interest, it struggles to compete when interest rates rise." ...WSJ

Gold does not "struggle to compete" with anything. Gold is real money. Its value is intrinsic. Any measurable changes in its nominal price are inversely attributable to one thing only - the value of the US dollar.

The implication apparently made by the author is that interest-bearing assets are preferable to gold. In that case, please see my earlier paragraph above "Between 1971-80...".

We are currently experiencing an extended period of artificially low interest rates. Nothing in our country's history compares to it. Any return to normal, free-market determination of interest rate levels should be welcomed. Unfortunately, that is not likely to happen.

The extremes experienced in the 1970s were the result of inflation foisted upon us by the government and the Federal Reserve. This began back in 1913 with the origin of the Federal Reserve. Today's extremes of zero interest and negative interest are the results of Federal Reserve influence in order to combat the variety of negative symptoms arising from the problem which they themselves created - a US dollar that has lost ninety-eight percent of its purchasing power.

Generally, in a free market, interest rates will seek their own level. That level will be reflective of: 1) credit supply and demand and 2) credit risk factors.

With the overwhelming amount of US Treasury debt which is placed continuously, there are two other factors which have become just as important and critical in determining the level of interest rates: 1) inflation (premium) and 2) 'crowding out'.

Inflation is what the government does best. The erosion in value of the US dollar has been intentional and continuous for over one hundred years (practice makes perfect). As a result, lenders must always allow for the eventual return of their capital at a lesser value. Therefore, all interest rates have an inflation 'premium' built into them which helps compensate for the expected loss in value over the duration of the loan.

Re: 'crowding out'... The US Treasury is the largest borrower in the entire world. The size of their debt dwarfs all other lenders. Hence, it has a much bigger influence in the credit markets. Every other lender and borrower gauges their own activity - especially rate setting and loan duration, and sometimes timing - with respect to whatever is occurring in the US Treasury Market.

The major banks that initiate the placement of US Treasury debt do so with an absolute priority afforded to no other lenders. The US Treasury debt must be subscribed fully and strongly. It is the source of funding for the ongoing day-to-day activities of government. And since the government doesn't care how much they have to pay in interest (you don't really think they care, do you?) they get what they want.

Gold bears no interest for a very specific reason. It is real money. Furthermore, it is original money.

The US dollar and all paper currencies are substitutes for real money. They are an outgrowth of warehouse receipts for real money (gold). More recently they were IOUs for real money (redeemable for and convertible into gold). Now, they are pieces of paper which supposedly represent 'real wealth'.

Owning and loaning dollars has its own set of special risk factors. Thus, any interest earned is a form of compensation for assuming that risk.

 

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