One potential criticism of the gold standard (fixing the dollar to gold) is that it would lead to high interest rates. This is wrong. This implies that weak currencies (or weakening currencies) cause interest rates to decline and that strong currencies or strengthening currencies cause interest rates to rise. This is utter nonsence and there is a vast body of empirical evidence against such a proposition. Currency devaluation (ie weakening) or even the mere threat of devaluation generally drives up interest rates. Strong currencies generally have low interest rates.
In the 1990s and early 2000s the YEN was so strong (the deflation even registered in the CPI) that ultimately interest rates could be set at 0%. During the 1970s when devaluation was the norm interest rates were consistently high nearly everywhere (except in parts of the US where high interest rates were illegal and so lending simply shut down).
Gold in so far as it might today be considered a currency has been very strong relative to nearly every major currency over the last 5 years. And yet interest rates for gold denominated debt are low. The chart below is from a selection by Kitco and shows the effective interest rate on gold denominated loans of various maturity terms during the last twelve months.
One of the traditional reasons that governments would return to the gold standard was because it would lower their cost of borrowing. Any currency today that was fixed to gold and which allowed interest rates to float free from capital controls would enjoy interest rates close to the interest rates on gold plus a slight premium to account for the risk of a future devaluation. Mere arbitrage alone would ensure such a near alignment with the interest rate on gold loans. Imagine having the opportunity to borrow gold at 1% interest, convert it to Aussie dollars and earn 20% interest and then convert it back to gold at the same exchange rate at any point in the future. Such a market scenerio would not be sustainable.
A gold standard gives you:-
- Low or absent CPI inflation
- Stable commodity prices
- Stable exchange rates (if others adopt a gold standard also)
- Low interest rates.
There are a million arguments about why a gold standard is a bad thing or why the world will end if we have a gold standard. However the empirical evidence across the ages all suggests otherwise.
UPDATE (by admin): The first sentence of this post originally referred to a comment by JC. However, it turns out that this was based on a misunderstanding of JC’s comment and following JC’s request the first sentence has been edited. The point of the article remains the same.