Rate Hike Hype & Gold

This article was written by Dickson Buchanan, SchiffGold Precious Metals Specialist. Any views expressed are his own and do not necessarily reflect the views of Peter Schiff or SchiffGold.

To hike or not to hike – that question continues to swirl around the Federal Reserve. But it obscures an even more significant question: what difference does it really make to the gold investor?

As I explained last week, the Fed finds itself in a damned-if-it-does, damned-if-it-doesn’t scenario. Regardless of whatever economic news spins out of Washington D.C. in the next few weeks, the central bank has plenty of reasons not to raise rates. As we’ve argued for months, the economy simply can’t sustain a rate-hike of any significant amount over the long-haul. But if the Fed balks at a rate hike yet again, its credibility takes another shot on the chin.

So, it might try to nudge rates up this month. Or, it may well put it off again. But what does this mean for gold? Does it really matter in the long run?

Not really. There are more important fundamentals to consider.

Conventional wisdom holds that if the Fed raises rates, it’s strong for the US dollar, therefore gold must go down in dollar terms. Or the opposite – if the Fed decides to not raise rates, that must be bullish for gold, and it will go up in terms of dollars.

The truth is that both of these narratives are wrong because they are based upon superficial and faulty premises. They ignore the fact that gold is a monetary commodity. As a result, it defies simplistic explanations as to its relative dollar price. Instead, you should look at gold as the only liquid monetary asset with no counterparty risk in a world where nearly every similar product carries with it enormous counterparty risk.

Simply looking at history shows us times when the dollar price of gold rose during periods of rising interest rates. It also records times when the dollar price of gold has declined during a falling interest rate period. This actually happened over the last 2 or 3 years. The following chart illustrates this point well.

Interest rates ballooned after Nixon disconnected the dollar from gold in 1971, and gold’s price in dollars subsequently moved from around $150 to over $600 by the end of the decade. Rising rates in the early 2000’s repeated the same phenomenon.

Simply put, a rate hike may or may not push gold lower.

Again, you have to think of gold as a monetary commodity. On the other hand, US dollars (and any other paper with government faces imprinted upon them) are simply a promise to pay – a liability. In truth, fiat currencies are nothing more than the outward facing door to a terrible mountain of debt that no one really knows how to get rid of.

The burden of this debt continues to grow. In fact, it must grow. The system is built that way. As the debt grows, so does the stress on the system. It becomes more of a strain just to pay the nominal interest. As the ability to repay becomes more doubtful, the risk of default grows. If sovereign debt defaults, then the entire system is at risk of breaking down.

The bubble will burst.

As a monetary asset and unit of capital, gold offers superior protection against such a broken system, no matter how the central bankers tinker with it.
A rise in rates might impact the price of gold in the short term, but it won’t eliminate the debt pile or the underlying economic issues. In fact, a rate hike will exacerbate the debt by raising the cost of those nominal interest payments.

So the bottom line is don’t get caught up in the rate-hike hype and the short-term impact it may or may not have on gold prices. As Peter put it last month, no matter what the Fed does, it is bullish for gold in the long term. In the meantime, just thank the Fed for extending the opportunity to buy gold for less than $1,100 an ounce.

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