Gold and a Crisis Delayed

“Is it just me or is the next market correction taking way longer than it should?” said a recent note we got from a friend. “In other words, have the powers that be figured out how to keep the music playing better than ever?”

It’s a great question. So much is riding on the answer. Late last year, a reader wrote in with a variation on the theme: “Kill and burn a goat, let’s get this show rollin’.”

The question and the answer are so important we’ll spend this entire episode of The 5 tackling a single subject — something we haven’t done in well over a year.

Let’s begin with a point we can all agree on: The United States has been in a persistent economic funk ever since the Panic of 2008.

“The U.S. economy has grown about 2% per year since 2009,” says Jim Rickards. “This rate is below the economy’s potential growth of 3%, and well below the pace of past recoveries.

“Following the recessions of 1980 and 1981, the U.S. economy grew at about 5% for several years before settling back to trend. The U.S. economy had record peacetime expansions in the 1980s and 1990s. That kind of growth is like a distant memory now.”

While the federal budget deficit and the national debt haven’t made big headlines in recent years, the problem hasn’t gone away. Indeed, it’s only grown.

Why haven’t we heard much squawking about the deficit and the debt? A lot of it has to do with the ultra-low interest rates we’ve experienced since the Panic of 2008. That year, the national debt totaled $10.02 trillion. Interest expense on that debt totaled $451 billion. A 10-year Treasury note yielded just shy of 4%.

At the end of fiscal 2015, the national debt had ballooned to $18.15 trillion — an 81% increase. But interest expense on the debt was lower than it was in 2008 — $402 billion. That’s because a 10-year Treasury note yielded only 2.15%. (This morning, it’s even lower — 1.95%.)

The Federal Reserve’s zero interest rate policies have been brutal on savers… but they’ve been great for Uncle Sam.

Here’s the real problem: “While U.S. deficits have declined, they are still adding to the overall debt faster than the economy is growing,” Jim says.

This fact is critical. It comes down to a concept called “primary deficit sustainability” that Jim wrote about in his second book, The Death of Money. The absolute size of the deficit doesn’t matter. What matters is the trend of the deficit as a percentage of GDP.

“Think of nominal GDP [before inflation] as one’s personal income and the primary deficit as what gets charged on a credit card,” he wrote.

“Borrowing costs are interest on the credit card. If personal income increases fast enough to pay the interest on the credit card with money left over to pay down the balance, this is a manageable situation. However, if one’s income is not going up and new debt is piled on after paying the old interest, the bankruptcy is just a matter of time.”

Two years after that book was published, the trajectory is no different. “The U.S.,” he says, “is still on a path to fiscal crisis and loss of confidence in the dollar.”

Another point we can all agree on: The Federal Reserve’s efforts to lift the U.S. economy out of its funk haven’t worked.

And the Fed’s remaining tools are of limited utility: The Fed missed its chance to raise rates in 2010–2011 so it could cut them now.

The Fed could opt for negative interest rates, like they have in Europe and Japan now. But as we explained on Friday, negative rates appear to be backfiring: Rather than encouraging people to borrow and spend, people feel compelled to save even more than they did before.

The Fed could also return to the currency wars and cheapen the dollar, as it did in 2011. “But U.S. gains,” says Jim, “come at the expense of trading partners whose growth is either already lower than the U.S.’ (Japan and Europe) or dropping dangerously (China’s). In a globalized world, there’s no escape from a global slowdown.”

“Global elites are getting desperate to try something new to stimulate growth,” Jim goes on.

We saw hints of that “something new” in December — when President Obama and House Speaker Paul Ryan cut a budget busting deal with $680 billion in “targeted” tax breaks for special interests.

Jim says that’s just the beginning: “A new global consensus is emerging from elite voices such as Adair Turner, Larry Summers, Joe Biden and Christine Lagarde. The consensus is that the only solution to stagnation is expanded government spending on critical infrastructure, health care, technology, renewable energy and education. (In a Republican administration, more defense spending could be added to the list.)

“If citizens won’t borrow and spend, the government will! It’s the basic Keynesian idea from the 1930s without the monetarist gloss.”

But wait, you’re saying: Won’t that only bring us closer to the moment of “fiscal crisis and loss of confidence in the dollar”?

Jim hears you. “More government spending means more government debt,” he acknowledges. “Who will buy these added government bonds? How will the Treasury keep interest rates low enough so that a death spiral of higher deficits and higher rates doesn’t push the Treasury bond market to the point of collapse?”

For answers, we have to go back more than 70 years.

“Beginning in April 1942, shortly after the U.S. entered World War II,” says Jim, “the Fed agreed to cap interest rates on Treasury bonds to help finance the war effort. The cap meant that the Fed gave up its control of interest rate policy.

“The cap also meant that the Fed surrendered control of its balance sheet because it would have to buy potentially unlimited amounts of Treasury debt to implement the rate cap. (Such asset purchases had inflationary potential, but in World War II, inflation was managed separately through wartime price controls.)”

Once the war was over, the Treasury was understandably reluctant to cede control back to the Fed; the caps weren’t lifted until 1951.

But the precedent was set.

“The Fed and Treasury will reach a new secret accord, just as they did in 1942,” Jim says.

“Under this new accord, the U.S. government could run larger deficits to finance stimulus-type spending.

“The Fed will then cap interest rates to keep deficits under control. Capping rates will have the added benefit of producing negative real rates if inflation emerges as the Fed expects.

“The Fed can use open market operations in the form of bond buying to achieve the rate caps. This means the Fed would not only give up control of interest rates, it would give up control of its balance sheet. A rate cap requires a ‘whatever it takes’ approach to Treasury note purchases.”

So that’s how the powers that be will “keep the music playing.” But what does that mean for you?

“If deflation persists,” says Jim, “rate caps can force bonds to much lower levels (closer to where German bunds are today). Nominal rates and inflation would be in a race to the bottom in an effort to achieve negative real rates.”

Yikes. If you lend money today to the German government for 10 years, you get a pathetic yield of 0.26%. In other words, the 10-year Treasury yield would sink far below the record low of 1.4% reached in the summer of 2012.

Remember, as rates go down, prices go up. “This will produce big capital gains in U.S. Treasury notes,” Jim says.

“If inflation emerges,” says Jim, “the rate cap might be higher in nominal terms but still low enough to achieve negative real rates. In this scenario, gold would perform extremely well.”

But even if deflation persists, gold stands to benefit. That’s because “central banks such as the Fed cannot tolerate deflation,” Jim writes in his latest book, The New Case for Gold.

Deflation is devastating for the banks, whose loan losses grow. And it’s devastating for the government; if people’s wages don’t rise, there’s no additional income to tax.

“The Fed must have inflation,” says Jim. “They will do everything possible to create inflation.

“When all else fails, they can always use gold to create inflation out of thin air by simply fixing the dollar price of gold at a much higher level. Then all other prices will quickly adjust to this new higher price of gold.”

It’s what FDR did in 1933. “The U.S. government forced the price of gold from $20.67 per ounce to $35 per ounce. It wasn’t a case of the market taking gold higher; the market was in the grip of deflation at the time. It was the government taking gold higher in order to cause inflation” — which it did.

“Gold has a place in every investor’s portfolio,” Jim writes, “because it is one of the few asset classes that perform well in both inflation and deflation.”

What’s the time frame we’re looking at? “Rate caps will not arrive until mid-2017 at the earliest,” Jim tells us. “That’s because the current Fed cycle of rate hikes followed by rate cuts has to play out first.”

But as we said on Friday, confidence in central banks is cratering now. You don’t have to look far to find it in the mainstream. Only this morning we see the chief of foreign-exchange strategy at UniCredit Research telling the Dow Jones Newswires that “Central banks as well as markets have become aware that monetary policy has limitations.”

And the gold price is sniffing this out. Look at the powerful rally from six-year lows back in December…


Jim didn’t plan for his latest book, The New Case for Gold, to be published at this moment. But the stars do seem to be lined up. The official release date is still three weeks away, but the book is already No. 2 in the Business & Money section at Amazon.

Yes, you’ll learn why gold is set to thrive as the Fed enters a dangerous new era. But the book is also packed with how-to advice gleaned from Jim’s years of experience and extensive network of contacts. Should you store gold at home? How about overseas? Is it safe to buy online? What mistakes should you avoid?

All these questions are answered in The New Case for Gold. You’ll also learn about Jim’s “mystical” gold buying formula that tells you how much you should buy. That information alone is worth several times the $16.66 that Amazon is charging for the book.

But if you order from us today, you can get a signed hardback copy free — as long as you can cover the $4.95 shipping and handling. You’ll also get a no-obligation 60-day trial of Jim Rickards’ Strategic Intelligence. And you’ll have the chance to listen in on an exclusive intelligence briefing that details a bombshell about to hit the gold markets — drawing on information Jim’s learned from one of the most connected people in the gold world.

“In my private briefing,” says Jim, “I’ll share with you exactly what this insider shared with me… how we expect it to play out… and, most importantly, a solution set that will help you prepare… and prosper… from the aftermath.”

It’s an unbeatable combination… and it’s available only at this link. Publication is set for Tuesday, April 5. We’ll ship the book to your door as soon as it comes off the press.

Thanks for your forbearance today as we slogged through some complicated issues. But we know you’re wondering why the inevitable crisis is so long in coming… and whether it can be forestalled a while longer.

Now you know, yes, it absolutely can. But you don’t want to wait to shore up your financial defenses. Take advantage of this window of opportunity. Jim’s providing the ideal playbook to get started.

As always, we appreciate your continued readership. We’ll get back to regular programming tomorrow.

Happy Pi Day,


Dave Gonigam
for The Daily Reckoning

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