Kendall Rule Revisited

Yellen’s Inadvertent Gold Standard

Nathan Lewis posted an excellent piece on Forbes about gold’s correlation with the dollar during Yellen’s tenure as Fed Chair.  Lewis asks the question, “have we effectively recreated the Bretton Woods gold standard system?”  Bretton Woods linked the dollar to gold at a fixed value of $35 per ounce.   

Lewis observes the positive effects that occur when currency is stable in value.  Lewis notes that, “the last two decades of the gold standard era, the Bretton Woods period of 1944 to 1971, were among the most prosperous of all of American history.”  That’s a fact that is hard to ignore–unless you’re an economist, and the monetary stability of gold is your kryptonite.

The Founding Fathers instituted a gold standard in 1789.  The U.S. maintained its gold standard after World War I while Great Britain allowed its gold standard to lapse.  Great Britain’s abandonment of its gold standard—where the sun never set on the British Empire—ended its empire with a whimper.  England proceeded to slouch into socialist irrelevancy.  The U.S. continued to gain in economic prowess and power.  All empires throughout history have been built on a foundation of stable money defined by gold. 

The U.S. started from nothing and rose to the top of the global economic pyramid by maintaining its gold standard.  When Nixon terminated Bretton Woods in 1971, the entire world abandon gold as a monetary reference.      

Fed Chairman Alan Greenspan understood gold and maintained a rough link to gold at $350 per ounce during his term.  This period of semi-stable monetary management that resulted in rapid growth is now known as the Great Moderation.  Greenspan’s maintenance of the dollar and its rough link to gold was a direct result of the Fed’s open market operation (OMO) policy.  Greenspan targeted the funds rate, which directly influenced base money supply, to maintain the dollar around $350 per ounce of gold.

Yellen’s Fed had no direct OMO policy that could adjust the supply of base money to establish a direct link with gold.  Yellen inherited $2.7 trillion of excess reserves (ER) when she became Fed Chair.  Other than regulating the banks that held these excess reserves by telling them how much ER to maintain, there was no way for Yellen’s Fed to adjust the supply of base money against demand.  By accident due to the anomaly of ER, Yellen’s Fed did create a sort of crude, unofficial gold standard from July 2015 until June 2018.  The Fed policy of paying interest on excess reserves created an equilibrium between base money supply and demand.  This equilibrium followed the duration of debt, or the optimum price of gold, without direct Fed policy.  June 2018 is when the POG stopped tracking the duration of debt and began a deflationary fall.  Recognizing Yellen’s inadvertent gold standard, I was able to accurately define the POG over the three-year period by a rule, the Kendall Rule.

“As long as excess reserves persist, with IOR, in amounts necessary to facilitate Federal Reserve control of the price of interest, the trend for the minimum price of gold is determinative by its average price over the duration of debt.”

I showed gold’s correlation with the Kendall Rule in a graph.


This three-year period was not a gold standard in the correct sense that the Fed maintains the POG at a fixed dollar value.  The POG rose from $1100 in July 2015 to $1300 in June 2018 before it’s deflationary fall to $1200.  It is an inadvertent crude correlation with gold that occurred in our floating fiat system.  The POG roughly correlated with the duration of debt which was increasing around 5 percent a year.  So the dollar was not stable in value under Yellen’s accidental gold standard, but was far, far better than Bernanke’s tenure that saw wild swings in the POG.  Only by comparison to Bernanke’s gross mismanagement, does Yellen look good.

The End of the Kendall Rule

A key part to the Kendall Rule is this:

“in amounts necessary to facilitate Federal Reserve control of the price of interest” 

With normalization the Fed is no longer controlling interest rates at the zero bound.  Therefore, the POG is no longer tracking the duration of debt.  The POG is now indicating a deflationary dollar.  In my view, Yellen’s inadvertent gold standard is no longer in effect.  The Kendall Rule no longer defines the POG.

Note that the duration of debt, also termed the optimum POG, determines the minimum POG.  When gold tracks the duration of debt at a minimum, it is not deflationary.  Today with a breakdown of the Kendall Rule due to normalization, the POG is no longer tracking the duration of debt.  The POG is below the duration of debt and is deflationary.

Kendall Rule Explained

Kendall Rule Update



Leave a Comment

Your email address will not be published. Required fields are marked *