The Golden Solution to America’s Debt Crisis
Right now, the United States is officially $27 trillion in debt. Nearly $7 trillion was added since President Trump took office.
This year’s budget deficit is projected at $3.3 trillion, over three times last year’s estimate. The coronavirus is responsible, and the number should be an outlier. But annual deficits will be at the trillion dollar level for the foreseeable future.
Basically, the United States is going broke.
I don’t say that to be hyperbolic. I’m not looking to scare people or attract attention to myself. It’s just an honest assessment, based on the numbers.
Now, a $27 trillion debt would be fine if we had a $50 trillion economy. But we don’t have a $50 trillion economy. We have about a $21 trillion economy (at least we did), which means our debt is bigger than our economy.
When is the debt-to-GDP ratio too high? When does a country reach the point that it either turns things around or ends up like Greece?
Economists Ken Rogoff and Carmen Reinhart carried out a long historical survey going back 800 years, looking at individual countries, or empires in some cases, that have gone broke or defaulted on their debt.
They put the danger zone at a debt-to-GDP ratio of 90%. Once it reaches 90%, they found, a turning point arrives…
At that point, a dollar of debt yields less than a dollar of output. Debt becomes an actual drag on growth. What is the current U.S. debt-to-GDP ratio?
About 130% (the reaction to the pandemic caused a spike. It was previously about 105%).
We are deep into the red zone, that is. And we’re not pulling out. The U.S. has a dangerous debt to GDP ratio, trillion-plus dollar deficits, more spending on the way.
We’re heading for a sovereign debt crisis. That’s not an opinion; it’s based on the numbers. How do we get out of it?
For elites, there is really only one way out at this point is, and that’s inflation.
And they’re right on one point. Tax cuts won’t do it, structural changes to the economy wouldn’t do it. Both would help if done properly, but the problem is simply far too large.
There’s only one solution left, inflation.
Now, the Fed printed trillions over the past several years, and trillions more over the past several months. But we’ve barely had any inflation at all.
Most of the new money was given by the Fed to the banks, who turned around and parked it on deposit at the Fed to gain interest. The money never made it out into the economy, where it would produce inflation.
The bottom line is that not even money printing has worked to get inflation moving.
Is there anything left in the bag of tricks?
There is actually. The Fed could actually cause inflation in about 15 minutes if it used it. How?
The Fed can call a board meeting, vote on a new policy, walk outside and announce to the world that effective immediately, the price of gold is $5,000 per ounce.
They could make that new price stick by using the Treasury’s gold in Fort Knox and the major U.S. bank gold dealers to conduct “open market operations” in gold.
They will be a buyer if the price hits $4,950 per ounce or less and a seller if the price hits $5,050 per ounce or higher. They will print money when they buy and reduce the money supply when they sell via the banks.
The Fed would target the gold price rather than interest rates.
The point is to cause a generalized increase in the price level. A rise in the price of gold from $1,900 per ounce to $5,000 per ounce is a massive devaluation of the dollar when measured in the quantity of gold that one dollar can buy.
There it is — massive inflation in 15 minutes: the time it takes to vote on the new policy. Don’t think this is possible? It’s happened in the U.S. twice in the past 80 years.
The first time was in 1933 when President Franklin Roosevelt ordered an increase in the gold price from $20.67 per ounce to $35.00 per ounce, nearly a 75% rise in the dollar price of gold.
He did this to break the deflation of the Great Depression, and it worked. The economy grew strongly from 1934-36.
The second time was in the 1970s when Nixon ended the conversion of dollars into gold by U.S. trading partners. Nixon did not want inflation, but he got it.
Gold went from $35 per ounce to $800 per ounce in less than nine years, a 2,200% increase. U.S. dollar inflation was over 50% from 1977-1981. The value of the dollar was cut in half in those five years.
History shows that raising the dollar price of gold is the quickest way to cause general inflation. If the markets don’t do it, the government can. It works every time.
But what people don’t realize is that there’s a way gold can be used to work around a debt ceiling crisis. I call it the weird gold trick, and it’s never seen discussed anywhere outside of some very technical academic circles.
It may sound weird, but it actually works. Here’s how…
When the Treasury took control of all the nation’s gold during the Depression under the Gold Reserve Act of 1934, it also took control of the Federal Reserve’s gold.
But we have a Fifth Amendment in this country which says the government can’t seize private property without just compensation. And despite its name, the Federal Reserve is not technically a government institution.
So the Treasury gave the Federal Reserve a gold certificate as compensation under the Fifth Amendment (to this day, that gold certificate is still on the Fed’s balance sheet).
Now come forward to 1953.
The Eisenhower administration was up against the debt ceiling. And Congress didn’t raise the debt ceiling in time. Eisenhower and his Treasury secretary realized they couldn’t pay the bills.
They turned to the weird gold trick to get the money. It turned out that the gold certificate the Treasury gave the Fed in 1934 did not account for all the gold the Treasury had. It did not account for all the gold in the Treasury’s possession.
The Treasury calculated the difference, sent the Fed a new certificate for the difference and said, “Fed, give me the money.” It did. So the government got the money it needed from the Treasury gold until Congress increased the debt ceiling.
That ability exists today. In fact, it is exists in much a much larger form, and here’s why…
Right now, the Fed’s gold certificate values gold at $42.22 an ounce. That’s not anywhere near the market price of gold, which is about $1,900 an ounce.
Now, the Treasury could issue the Fed a new gold certificate valuing the 8,000 tons of Treasury gold at $1,900 an ounce. They could take today’s market price of $1,900, subtract the official $42.22 price, and multiply the difference by 8,000 tons.
I’ve done the math, and that number comes fairly close to $500 billion.
In other words,the Treasury could issue the Fed a gold certificate for the 8,000 tons in Fort Knox at $1,900 an ounce and tell the Fed, “Give us the difference over $42 an ounce.”
The Treasury would have close to $500 billion out of thin air with no debt. It would not add to the debt because the Treasury already has the gold. It’s just taking an asset and marking it to market.
It’s not a fantasy. It was done twice. It was done in 1934 and it was done again in 1953 by the Eisenhower administration. It could be done again. It doesn’t require legislation.
Would the government consider the gold trick I just described? I don’t know.
But the real message is that the solutions to current debt levels are inflationary. That means revaluing the dollar either through a higher gold price or marking the gold to market and giving the government money.
There’s a lot of moving parts here, but they all point in one direction, which is higher inflation.
It’s the only way to keep America from going broke. Unfortunately, it will also make your dollars worth less.
for The Daily Reckoning