The Money Trilogy: Gold, Interest Rates and the Dollar

Article excerpt


Sometimes the best trading systems are based on simple proven concepts without a lot of modification to muck up the process. One basic fundamental relationship exists among gold, interest rates and the dollar. Here, we explain the link in both historical and modern-day terms and show some straightforward ways to exploit it.

Currency, gold and interest rates have a complex interaction that has worldwide effects and a strong historical basis. Gold has been used as a currency for millennia. At one time, most of the world defined its money relative to gold. The world long has abandoned the Gold Standard, but gold as a currency link still weighs on the monetary system.

The interaction between gold, currencies and interest rates affects current and future mortgage rates, corporate profits and the strength of the job market. It is important to examine this relationship and its interaction in today's world markets. Having done so, the next step is developing some simple trading strategies based on what we have learned.


The concept of the Gold Standard was simple; governments and central banks declared that their individual currencies could be exchanged for a fixed amount of gold. As long as the world used the Gold Standard, overseas investment could be based on the relative merits of the investment itself without worrying about currency risk. The United States' founding fathers believed in the Gold Standard. Once the United States won independence "with a gold guarantee, government could not steal resources from the people by printing money," Alexander Hamilton said in 1791.

The Gold Standard became accepted worldwide as Germany joined Great Britain and the United States in defining its currency in terms of gold. The Gold Standard controlled the risk of inflation from printing too much money because national treasuries had to consider the possibility of individuals demanding gold for the printed notes. Also, the value of a country's currency was based on its gold reserves, so this stopped the national treasuries from printing money to handle national debt. Therefore, each country's domestic money supply was linked directly to its domestic gold reserves.

The United States' commitment to the Gold Standard was not absolute, and it was abandoned for a time during the Civil War to allow for the printing of money to pay for the war effort. The Gold Standard was resumed in 1879. That the United States was vacillating with regards to gold policy hurt the dollar because it created monetary uncertainty. In the late 1870s, German demand for gold pushed gold prices higher and American efforts to mine silver increased and pushed silver prices lower. Many countries, including the United States, began defining currency using both gold and silver. The United States suspended this two-metal money standard in 1873, and money was minted in both gold and silver using a price ratio of 1/15 of gold until the 1930s and 1/16 afterward. Because silver production was increasing rapidly during the late 1860s, the government demonetized silver and suspended silver coinage before the price of silver dropped.

The Bland-Allison act of 1878 reintroduced silver into coinage. The United States government wanted to suspend silver coins because it was concerned that people would turn the silver coins in to the Treasury in exchange for gold and deplete U.S. gold reserves. So-called Inflationists wanted this return to silver coinage at the old ratio of 16 ounces of silver to one ounce of gold. They wanted the government to issue more money than could be backed by gold so they could pay back debts with cheaper money than they had borrowed. Business leaders wanted to stay on the pure Gold Standard because they where afraid of inflationary problems. During the panic of 1893, many people exchanged money into gold and the Untied States gold reserves fell to dangerously low levels. …