There has been a lot of talk lately about golds correlation to rising interest rates. With this post we will explore what will happen to gold when the interest rates goes up.
What does it mean with rising interest rates?
Is it good or bad for gold?
The reason why there is so much talk about golds correlation to interest rates is because in December 2015 the Federal Reserve raised the interest rates for the first time in over a decade.
We’ve had historically low interest rates since 2008
After the financial crash of 2008 people were afraid that this was the end of the financial system as we know it. Money would stop coming out of ATMs, big banks would fail which would mean billions of dollars lost for average people.
It was called financial Armageddon and the Federal Reserve had to do something (although they were very much involved with creating this financial disaster) to backstop this crash.
What they did was to bail out the big banks. Instead of bailing out the millions of people that were left homeless, jobless and poor they bailed out the big banks. The people that had been taking these risky bets and accumulated so much debt that they brought down the financial system.
After the bailout to prevent the whole economy from failing there was a new big question. How do we kickstart the economy again?
What they would come up with is something that has never really been tried before in documented history. Zero percent interest rates.
Interest rates is one of the most important factors in a free market. It sets the price on risk. If I loan money from you and you charge me a 10% interest rate then that is the price you want for the potential risk that I wont pay you back.
With the federal reserve (Americas central bank) putting interest rates at zero they basically said that loaning out money had no risk to it. If you lend me money I would only pay back what I owed you, meaning that it was now ”free” to loan money from you (you in this sentence being the bank).
Why would interest rates at zero help to kickstart the economy? You might ask.
Well, what they wanted to achieve was that people, corporations and governments should start to loan a bunch of money again and spend it. Because it’s now ”free” to loan money this extra liquidity was suppose to be used to build factories, roads and other job creating things. This would kickstart the economy they said.
Have a look at the chart below which is the US interest rates since 1960. As you can see the average is around 5-6% but since 2008 the interest rates has been at 0%. All to fuel another bubble just like the one that popped in 2008.
Rising interest rates will prick the debt bubble
First of all I want to say this: We had a financial crash in 2008 which almost brought down the whole worlds financial system because we had too much bad debt.
What is the Federal Reserve’s way of fixing it? By creating more bad debt! Because zero percent interest rates will do just that, create more bad debt.
Why is zero percent creating more bad debt? You might ask.
It’s fairly simple. Like we discussed above low interest rates means that it’s very cheap to loan money. Because it’s almost free to loan money more people, companies and governments will use this to maybe get a new car, buy back some of their own stock or to spend more money on the military.
This is all good as long as the interest rates are low. Because then it can be paid off. But what happens when the interests rates goes up and we can no longer afford the monthly payments on all the bad debt that we’ve accumulated?
This is exactly what is happening. People and organizations are buying things on credit that they normally couldn’t afford just because interest rates are so low. Once the interest rates rise a lot of these loans will default and we are back at the crisis levels of 2008.
This is just fueling another bubble just like 2008. In 2008 it was contained just to housing but it was created because of interest rates for houses were too low, lending standards were to weak and that you could move into a house with zero to none down payment.
Because everyone could easily borrow money the housing prices were bid up to unsustainable levels (forming a bubble). And all bubbles pop!
The same thing is happening right now but the bubbles are being formed everywhere. A car bubble, new housing bubble, stock market bubble and bond market bubble.
A lot of the assets around the world are getting artificially propped up with all this cheap money from zero percent interest rates.
The bottom line is that nothing that the Federal Reserve did after the financial crisis of 2008 fixed any of the underlying problems, it only made them bigger. We still have a debt problem and we can sustain this huge amount of debt because of zero percent interest rates but rising interest rates will prick the debt bubble. The 2008 financial crisis will be nothing compared to the coming one.
Lets have a look at the US government for example. You have probably heard the stupid amount of debt that they have accumulated. It’s quickly reaching 20 TRILLION DOLLARS (let that sink in) as I write this.
If the interest rate on the national debt would go up, just to say 3%, almost half of the governments income from taxes and other things would go towards paying off the interest on the national debt.
The government would have to default directly because they could never afford to pay that amount and still pay the military, roads, social security and other obligations.
Why is rising interest rates good for gold then?
I think that you have understood that after 2008 we tried to kickstart the economy by lowering interest rates to zero which created even more bad debt that was the root of the problems in 2008. We can afford to service this debt because the interest rate is so low today. But when the interest rate start to rise it will prick this giant debt bubble and we will see a bigger financial crisis than 2008.
So why would this be good for gold you might ask?
One of the biggest reasons for why people invest in gold is because it’s a safe investment. It has withstand wars, stock market crashes, empires fall and all other things you can think of and always kept it’s purchasing power.
When people see tough economic times ahead they always turn to physical gold to protect their wealth, These people will drive up the price of gold because of simple supply and demand. When more people are buying something, the price goes up.
We can easily prove this. As I said in the beginning of the article the Federal Reserve decided to raise interest rates in December of 2015. Let’s have a look at what happened to the price of gold then.
As you can see gold had been going down for a while but when the Federal Reserve (FED) decided to raise the interest rates gold just reversed and is up around 25% in 6 months. This is a huge move for gold.
The reason why is because big investors know that when the interest rates rises the party is over and we will have a worse financial crisis than 2008. By buying gold they will protect themselves from the coming crisis.
The interest rates will go up on day. Either by the central banks pushing it up themselves (not very likely because they know that will pop the bubble) or by market forces. But interest rates will not be able to stay at 0% for ever and asset prices will not continue to rise for ever.
As I said, when the interest rates rises the party is over. If you stand holding only paper assets by then you will have a very hard time. Move some of you assets into physical gold today as a protection against the coming economic collapse.
See it as insurance on your money. Just like you have insurance on your house you should have insurance on your money. You do this by putting between 10-20% of your investment capital into physical gold bullion.
Please leave a comment below if you have any input. I love to talk about this stuff so don’t hesitate. Otherwise you should have a look at my top 3 reasons for why you should start to invest in gold today.