I’ve had some folks write in and ask questions about gold in a high interest rate environment.
You might remember that in the late 1970s, early 1980s, gold prices didn’t cease their march until Paul Volcker famously raised the Federal Funds rates to slow down inflation. It’s crazy to think how high he raised rates, but peak rates got up to 20% in 1981.
That pushed Treasuries to yield more than 20%!
I’m certain, of course, that raising interest rates to Volcker levels would result in falling gold prices. I’d love to own an asset that returned 20% a year, regardless of whether it’s called dollars. Heck, if horse manure paid 20% you wouldn’t turn up your nose.
But for the foreseeable future, I just don’t see rates rising to those levels. Remember that rates averaged over 11% in 1979 - when gold prices doubled from $230 an ounce to over $500 an ounce.
The Treasury bond yield is just one indicator that would signal an end to the bull run in gold, but it’s a very important one. For many investors in the gold market, they’re buying gold to preserve capital. But when they see Treasury bonds yielding double digit returns, they’re keen to ditch gold. Not all of them, of course, but enough to start felling dominoes.
There are no guarantees that gold will continue double-digit gains forever. But a 30 Year Treasury bond yielding 20% certainly does make that guarantee.
It doesn’t seem very likely that Ben Bernanke would raise rates to 11% anytime soon - let alone higher than that level. But more importantly, I don’t think it’s possible at this point. That’s because the Federal Government has a current total deficit of about $14 trillion. Every percentage point increase in rates adds an astounding $140 billion to our debt load.
But the current Federal tax receipts of the United States add up to about $2 trillion annually. So if Bernanke raised rates to 11% - up from current levels of just 0.75% - that would mean an addition $1.4 trillion added to the Federal debt, just in interest alone.
I don’t have to tell you what happens when interest payments take up a large portion of your income. It’s unsustainable for individuals, it’s unsustainable for corporations, and eventually, it’s unsustainable for governments.
And it doesn’t seem likely that the Federal Government will be able to increase taxes to the extent that it would need to in order to make up the difference.
So, Bernanke is in a position where he’ll get pinched between needing to raise rates in order to combat inflation, and further bankrupting the country if he does so.
What’s he going to do? I don’t know, but almost anything he realistically can do is hugely bullish for gold.
Disclosure: long gold