Interest Rate Stability: The Primary Virtue of the Gold Standard

A company offers interest on gold, and the gold community goes ballistic. Why so visceral a response? To answer that, we need to look at the backdrop of today’s bizarre financial world.

Zero Hedge published an article on Canadian Bullion Services (CBS) last week. Other sites ran similar articles. The common thread through these articles, and in the user comments section, is that CBS is committing criminal fraud. Or, if not, then it’s a conspiracy by the Canadian government to confiscate gold. Terms like fractional reserve and re-hypothecation were dusted off for the occasion.

I don’t know anything about CBS other than what I read on that post. But I am writing to make a different point, not to accuse or defend CBS.

My point is: a company offers interest on gold, and the gold community goes ballistic. Why so visceral a response? To answer that, we need to look at the backdrop of today’s bizarre financial world.

Interest rates have been falling for well over three decades. This has caused endless asset bubbles in which to speculate to make a fortune (or lose one). And now, in the terminal stage of our monetary disease, there is scant yield to be had even in the U.S. Negative yields already prevail in several other countries.

We’re trained to not expect to earn interest, to not even think about it. Instead, we’re like Pavlov’s dogs who know to salivate at the sound of a bell. Only we’re not after food, but opportunities to speculate.

We have become accustomed to it. We’re trained to not expect to earn interest, to not even think about it. Instead, we’re like Pavlov’s dogs who know to salivate at the sound of a bell. Only we’re not after food, but opportunities to speculate. All we want to know is, what’s going up next. Mainstream folks prefer to speculate on mainstream assets like stocks and real estate. Gold bugs would rather bet on gold and silver. Either way, it’s the same: seek capital gains by the rising dollar price of an asset. Yield is as dead as the rotary dial telephone.

And, we’re beyond merely accustomed. People demand speculative bubbles. It feels right as rain—or the next dose of opiate painkillers. Besides, speculation is how you get rich quick. Especially with leverage. Interest is boring and slow.

As those articles I mentioned earlier show, many people who are accustomed to demand speculative capital gains are actually offended at the very promise of a yield. It’s cognitive dissonance. If speculation is how we are supposed to make money, then interest is a vestige of the old normal. It’s like a thorn under your skin that you can’t get rid of, an annoying reminder of days gone.

This touches on a point I frequently make: Gold does not go up or down. It’s the dollar that goes down or up. Unfortunately, we have long been trained to accept purchasing power as the means of measuring the dollar. For example, JP Morgan was worth $68M at his death in 1913. To calculate what that’s worth in today’s dollars, most people would refer to the Consumer Price Index. They use CPI to adjust the $68M figure from 1913 to a $1.6B modern value.

The approach is fatally flawed, because the value of a currency isn’t derived from prices. As an analogy, suppose you are using a steel meter stick to measure a rubber band. When you stretch the rubber band, it gets longer. This is not equivalent to saying that the meter stick gets shorter. You do not measure meter sticks by how many rubber bands fit end to end. Measurement is one-way.

Money is the meter stick of economic value (though this principle is clouded in paper currencies, because they are falling). Prices rise or fall for non-monetary reasons. Prices may be cheaper or dearer for a variety of non-monetary reasons, like wages, productivity and so on.

However, now there’s a problem: how can you speculate on gold? I think so many people are so insistent on measuring gold in dollars for a simple reason. They want capital gains.

They want gold to go up, so they can get rich. This requires something to measure gold with. If gold is going up, then compared to what? The dollar!

Perversely, the fiat dollar suits the gold bugs as well as it suits the Federal Reserve (though for different reasons). Both believe that if everyone is forced to use the dollar as the unit of account, then they benefit from rising asset prices.

After the fiat dollar economy collapses, what comes next? There are two possibilities. One is a normal world where gold is used as money, and people can earn a return on their gold. The other is a collapse into a new dark age. Even in a dark age, gold is money all right. It’s just that no one wants to risk getting killed for his metal.

There’s nothing intrinsically wrong with borrowing, lending, or earning interest. In fact, the loan is a win-win deal.

There’s nothing intrinsically wrong with borrowing, lending, or earning interest. In fact, the loan is a win-win deal. It benefits the business which borrows in order to produce the things that people want. And it benefits the saver and the retiree who lend to earn an income on their savings. Productive lending is an integral part of the gold standard.

Here’s how it would work:

If people are free to own gold coins directly, then the mechanics of setting the rate of interest are simple. Let’s define a term. The marginal saver is the saver who could go either way, either holding a bond or a gold coin. If the rate of interest ticks downward, he will sell the bond (or withdraw his money from the bank, thus forcing the bank to sell the bond) and buy the gold coin. He would rather hold the gold than commit to the time and risk for such a low interest rate. If the rate of interest ticks upward, he will buy the bond (or deposit his coin in the bank).

The marginal saver sets the floor under the rate of interest. It cannot fall below his preference or else he will vote with his gold. His preference has real teeth (unlike today).

Now let’s define one more term. The marginal entrepreneur is the entrepreneur whose rate of profit is the lowest possible, while still being viable. If his profit falls for any reason, such as due to a rise in costs, he will shut down his enterprise. One cost is the cost of capital, i.e. the rate of interest. No entrepreneur can borrow at a rate higher than his rate of profit, and the marginal entrepreneur is the first to buy the bond and sell his capital stock at an uptick in the rate of interest. He is the first to sell a bond and buy capital stock at a downtick in the rate.

Under a proper gold standard, the rate of interest is kept in a band that is not only narrow, but which is also stable over long periods of time. This is the principal virtue of the gold standard.

The marginal entrepreneur sets the ceiling over the rate of interest. It cannot rise above his ability to pay, or else he will vote with his capital stock. He also has teeth.

Under a proper gold standard, the rate of interest is kept in a band that is not only narrow, but which is also stable over long periods of time. This is the principal virtue of the gold standard. It does not fix the level of prices, which would be neither possible nor desirable. It keeps the rate of interest consistent, which serves the interests of wage earners, pensioners, and other savers, and of entrepreneurs whose work provides the goods, services, jobs, and interest payments on which everyone else depends (and which they take for granted).

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About the Author: Keith Weiner

Keith Weiner is president of the Gold Standard Institute USA in Phoenix, AZ, and CEO of precious metals fund manager Monetary Metals. He created DiamondWare, a technology company that he sold to Nortel Networks in 2008. He speaks and writes about free markets, money, credit, and gold.