The Gibson Paradox: Real Gold, Interest Rates and Prices

Adam Abdullah

doi:10.5539/ibr.v6n4p32

Abstract

This paper aims to provide an analysis and explanation of the curious empirical relationships that exist between the price of gold, the interest rate and commodity prices, operating under the English 19th century fractional reserve gold standard and the modern American fractional reserve fiat paper standard, known as the Gibson Paradox. This paper argues that the value and purchasing power of the British pound and American dollar are managed in relation to their rate of exchange with gold and the real rate of interest, such that, changes in the general level of prices are the effect and not the cause.

Highlights

This paper attempts to offer a satisfactory explanation regarding the relationship between interest rates and prices, a perplexing phenomenon that perhaps is otherwise better known as the Gibson paradox
It would seem that the Gibson paradox in England contradicts the quantity theory, which would expect the supply of money to determine commodity price inflation, being independent of interest rates, whereas under the gold standard, commodity prices and interest rates were positively correlated and moved in tandem over the long term
The Gibson paradox in the United States was reflected in the inverse relationship between real interest rates and the purchasing power of gold, or if the price of gold was fixed, interest rates can be maintained at low levels

Summary

Introduction

This paper attempts to offer a satisfactory explanation regarding the relationship between interest rates and prices, a perplexing phenomenon that perhaps is otherwise better known as the Gibson paradox. The paradox did not go unchallenged, Macaulay (1938) stated: It is true that, in various countries and often for long periods of time, the movements of interest rates (or rather bond yields) and commodity prices have been such as to suggest that they might be rationally related to one another in some direct and simple manner. Vol 6, No 4; 2013 under the gold standard, the movements of commodity prices and nominal interest rates were similar to the inverse relationship of the relative price of gold and real interest rates under the fiat standard, and taking into account gold as an asset in relation to other financial assets might explain the anomaly The second section, presents analysis of the Gibson Paradox in the United States under the fiat standard, and the third section provides a brief summary and concluding remarks

Gibson Paradox in England

Gibson Paradox in America

Findings

Conclusion