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The National Debt and Gold
A cautionary tale told in four straightforward charts

USASeal"President Trump, in complete contradiction to candidate Trump, has praised Yellen for being a 'low-interest-rate-person.' One reason Trump may have changed his position is that, like most first-term presidents, he thinks low interest rates will help him win reelection. Trump may also realize that his welfare and warfare spending plans require an accommodative Fed to monetize the federal debt. The truth is President Trump’s embrace of status quo monetary policy could prove fatal to both his presidency and the American economy." – Ron Paul, Institute for Peace and Prosperity

Editor's note: This issue of our newsletter features several interactive, live charts offered in conjunction with the St. Louis Federal Reserve and the ICE Benchmark Administration/LBMA. You can access statistical details by moving your cursor over the charts. If the chart does not automatically update, please move the toggle button on the year bar all the way to the right. We invite you to bookmark this edition for future reference.

CHART 1: Sustained by both political parties, the national debt has taken on a life of its own


Since the early 1970s, the logic for gold ownership has been inextricably bound to the cash flow problems of the federal government. As the national debt increased so did the well-documented damage associated with it – to the dollar, to financial markets and to the economy in general. Simultaneously, gold's role as an inversely correlated portfolio hedge grew over that nearly one-half century as well.

As you can see from the chart above, which shows the percent change in the national debt from the previous year, those problems do not favor any particular political party or president. In a certain sense, it has taken on a life of its own, marching to over $20 trillion without regard to party ideology. I mention that for the benefit of those who might think that somehow things might be different under a Trump administration. In fact, the greatest percentage growth in the national debt occured surprisingly during Republican administrations.

"As GOP lawmakers are struggling to enact an agenda of spending and tax reform," says one journalist, "they continue to face the painful reminder that Trump has no ideological drive to tame the deficit. The President has made clear that he doesn't mind if deep tax cuts result in a ballooning of the national debt."

CHART 2: How the national debt and the Fed could bankrupt the nation


Democrat Franklin Delano Roosevelt was the first to publicly declare that deficits did not matter since, he reasoned, we owe the money to ourselves. Dick Cheney, who should have known better, made the same claim on behalf of Republican deficits. Deficit denial has never held water simply because holders of government paper, foreign or domestic, intend to be repaid and with interest. It’s that part about creditors demanding interest that blows a hole in the “deficits-do-not-matter” argument. One of the stand-out features of the chart above is that, as interest rates have declined over the last several years, the interest paid by the federal government has increased markedly due to the rapid growth in size of the accumulated debt.

Some quick background:

* * * In 2008 when the national debt stood at $10 trillion, the federal government paid $336 billion in interest. For a measuring stick, the ten-year Treasury bill drew an average interest rate at the time of around 3.66%.

* * * In 2012 when the debt crossed the $16 trillion threshold, the interest payment was almost $456 billion. The ten-year Treasury bill drew an average interest rate of 1.80%.

* * * In 2016 with the national debt approaching the $20 trillion mark, the interest payment was $497 billion. The ten-year Treasury bill drew an average interest rate of 1.84%. It is difficult to overlook the fact that 2016's interest payment was an all-time record at the second lowest rate on the 46-year chart.

* * * If the ten-year Treasury bill were to rise to 2.82% (the average since 2007), the implied interest payment would exceed $750 billion, 20% more than what the United States spends annually on the national defense.

* * * If the average interest rate were to double from current levels (about 3.7% on the ten year Treasury bill), the United States would pay almost $1 trillion annually in interest on the national debt, or nearly one-third of 2016 tax revenues ($3.27 trillion). At that point, markets might begin to question the solvency of the U.S. federal government.

The exercise above points up the limitations on the Federal Reserve with respect to raising interest rates. It is a cautionary tale told in some very big numbers that promise to become even larger. In short, the onerous public debt has hamstrung the Fed in ways that policy-makers are loathe to discuss publicly. The Federal Reserve either keeps a leash on interest rates, or it bankrupts the nation.

CHART 3: The national debt is the ultimate threat to the dollar's reserve currency status

In the worst-case scenario, the accumulated debt and interest payments reach levels the markets find intolerable, threatening the dollar's reserve currency status and foreign creditors' confidence in U.S. Treasury paper. We came perilously close to that in 2011 when Standard & Poor's downgraded America's credit status citing the lack of "effectiveness, stability and predictability of American policymaking and political institutions." Since then, an argument could be made that things have only gotten worse. Not only has the red ink flowed at an unprecedented rate, the U.S. debt to GDP ratio has gone from 62% in 2007 to 105% now. Among the G-20 nations, the United States now has the third worst debt-to-GDP ratio. Only Japan and Italy have worse. One cannot help but wonder what might lie ahead as we enter a new round of Washington wrangling over government finances.

CHART 4: The national debt has made gold a superstar

Few correlations in the financial markets ring truer and more consistently than the one between the federal debt and gold. That relationship between the two is about as fundamental as it gets because it goes to the heart of what's wrong with the debt-based fiat money system. As the federal government borrows more and more dollars into existence and the banking system pushes those dollars through the global monetary system, it diminishes the value of all the other dollars already being held somewhere by somebody – domestic private investors, financial institutions, foreign governments and central banks, et al.

With respect to foreign holders of the U.S. sovereign debt, the process begins with trade imbalances that are later converted to Treasury paper in order to earn a yield. This process of replication simultaneously showcases gold, which cannot be replicated at will, as the dollar's counterpoint and chief competitor – a superstar portfolio holding for reasons French president Charles DeGaulle famously outlined in his "Criterion" speech delivered in 1965. France set the tone and strategy for dealing with the "export" of dollars, as he described it, by converting those imbalances to gold and taking delivery within French borders.

From that time forward global investors, both private and public, have followed the French model with China's current gold acquisition program the most notable recent example. The result is what you see on the chart. For those with capital preservation as the goal, gold has been a stalwart and productive ally since the United States went off the gold standard in 1971 and launched the era of fiat money, federal deficits and the massive federal debt.

As for the future, we should keep in mind that the very same conditions which created the long-term secular trend for both the national debt and gold are still in place today – nothing has changed fundamentally. As long as that is the case, we can assume gold will continue to attract capital as a long-term portfolio hedge just as it has, to varying degrees, through the first 46 years of the fiat money system. Please note, too, that gold is trading below the federal debt's trend line, an indication that it might have some catching up to do in the months and years ahead.


The benefit of a regular gold accumulation plan

I got the idea for the following chart from Incrementum's Ron Stoferle and Mark Valek and I highly recommend the 2017 version of their annual report on the gold market, In Gold We Trust. "The average annual price," they say, "puts the recent gold price correction in perspective [and] clearly shows the benefit of a regular accumulation plan (gold savings plan) as a long-term strategy."

Four steps to becoming a successful gold and silver investor

A healthy skepticism.

Those were the four characteristics almost all gold investors had in common in 2001. I can tell you that, from personal experience, we at USAGOLD helped a good many become gold owners in those times and listened carefully to what they had to say. Gold was stuck under $300 per ounce. Anti-gold rhetoric was all the rage in the mainstream financial media. The general public was high on stocks and apathetic about gold ownership. Stocks would rise forever, they thought, and gold would never rise again.

Sound familiar?

The prevailing psychology in those years was fertile ground for the contrarians and pragmatists who accumulated gold at what turned out to be bargain-basement prices. They understood that the economy and financial markets were not all they were cracked up to be (A healthy skepticism). They understood the inviolable law that markets cycle (Insight). They understood gold's role in the long-term portfolio (Belief). They acted on that belief despite much opposition and criticism (Courage). A good many invested enough to preserve their wealth while some some invested enough to, in fact, become very wealthy – even though their intentions for the most part were merely to preserve what they already had.

What do you need to do to garner a real rate of return on your money these days?

How much would your investments need to appreciate over the past 12 months in order to garner a real rate of return? Well, that is not as straightforward an analysis as you might think. It all depends on who you want to believe regarding the real inflation rate.

If you use the federal government's version, anything over about 1.3% (CPI growth rate, annualized) would have done the trick. If you use Shadow Government Statistics' (SGS) inflation number, which is based on the Bureau of Labor Statistics' 1980-based statistical methodology, that rate of return would needed to have been more on the order of 10% or better. (Please see chart below.)

As for the longer term, the second chart illustrates delivering a solid real rate of return against the CPI in twelve of the past sixteen years. In seven of these years (2002, 2003, 2005, 2006, 2007, 2009 and 2010) gold's appreciation significantly outstripped the inflation rate. Even against the SGS' elevated 1980s-based inflation rate, gold has delivered significant real returns in seven of the past sixteen years and adequate returns in three more. Over the period since the 2008 financial crisis, it has beaten the SGS' inflation rate by roughly 5.75% per year (compounded), even with the down years blended into the overall returns. With both metals currently trading at cyclical lows, you can now combine hedging the worst-case scenario with the extra advantage of securing an asset that is generally viewed as undervalued.


Interactive chart offered in conjunction with the St. Louis Federal Reserve and the ICE Benchmark Administration/LBMA

Notable Quotable

• "A financial strategist at a major investment bank in Europe recently told me he keeps two-thirds of his personal investment portfolio in a global stock portfolio and the remaining third in gold bullion. He’s not a crazy, far-right conspiracy nut or classic gold bug either. So why all the gold? 'Political risk,' he says. 'It’s my insurance against the world’s governments or central banks screwing things up.'" – Brett Arends, MarketWatch

• "So the modern world may be increasing in technological knowledge, but, paradoxically, it is making things a lot more unpredictable." – Nicholas Taleb

• "Despite all the mining operations worldwide, there is not all that much gold. Indeed, all the gold ever mined would fit into an Olympic swimming pool and is currently worth less than $7 trillion. For some years, we have viewed support for bullion’s relationship to the Dow Industrial range of a ratio to fall to 5 to 5.67; such a ratio would eventually take gold as high as $4000 per ounce at the current level of the Dow." – Alan Newman, CrossCurrents

• "When you think of the color gold, images of grandeur and extravagance are likely to come to mind. For millennia, the metal has adorned crowns and hilts of swords. It has been used to enhance paintings and ornaments to increase their value. In some cultures, gold is a predominant feature of festivals and celebrations. In Eastern cultures, the metal is an integral part of auspicious occasions like marriages and festivals by way of gifts and sacred rituals. Gold also features heavily on the attires of brides and grooms throughout South Asia. Humans' fascination with gold is as old as time itself. The scarce material has a certain appeal to it. Empires have flourished by possessing gold, wars have been fought to control regions harboring rich deposits of the metal and treasure hunters and explorers have spent a lifetime in search of it." – Puja Bhattacharjee, CNN

• "It is only relatively recently that Western capital markets have become aware that Chinese demand for physical gold absorbs large quantities of annual mine production, and that the country is now the largest mining nation by far, extracting it at a rate of over 450 tonnes per annum. Knowledge of China’s overall demand is restricted to deliveries out of the Shanghai Gold Exchange’s vault into public hands, running at about 2,000 tonnes per annum, which with India’s public demand accounts for nearly all global mine extraction of about 3,000 tonnes." – Alasdair Macleod, GoldMoney

• "Goldman Sachs has circulated a fascinating but scary research note to clients suggesting that the probability of stocks entering a bear market in the next 24 months currently stands at about 88%, based on the history of previous bear markets." – Jim Edwards, Business Insider

• "And I will leave you with some immortal words from legendary strategist Bob Farell: 'Markets tend to return to the mean over time. Excesses in one direction will lead to an opposite excess in the other direction. There are no new eras - excesses are never permanent. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways. The public buys the most at the top and the least at the bottom.'" – Kevin Muir, The MacroTourist

• "In a lot of cultures, the word for money derives from the word for gold. In China, the ideogram for money is the ideogram for gold." – Peter Oakley, Royal College of Arts (UK)

• "The really exciting thing is gold’s October seasonal bottom is the last one before this metal’s strongest seasonal rally of the year. On average gold’s winter rally propels it 9.5% higher in bull-market years by late February. That 9.5% winter rally well outguns the 6.9% average autumn rally that recently ended, and dwarfs the 3.8% average spring rally. We are right at gold’s most-bullish time of the year seasonally! Gold has real potential to enjoy a monster winter rally this year, especially if these insane stock markets start to roll over under the Fed’s just-unleashed quantitative-tightening juggernaut." – Adam Hamilton, Zeal LLC

• "Precious metals remain a relevant asset class in modern portfolios, despite their lack of yield.  They are neither a historic accident or a relic. . . Gold tends to preserve its real purchasing power over the very long run (albeit with substantial short-term deviations). Since Roman times, the real value of gold has remained more or less unchanged in the face of wars and political, social and technological shocks. Many investors therefore see gold as a way to hedge against structural tail risks, which could potentially erase the real value of all other financial assets." – Jeffrey Currie and Michael Hinds, Goldman Sachs commodity analysts.

• “By 2020–2022 we would see record high gold prices in terms of nominal annual average prices. For the annual average price to be $1,650 or $1,700, that means that you're going to have gold prices knocking on the door of $2,000.” – Jeffrey Christian, CPM Group, Managing Director

• "In 1999 gold began to rally, and few could figure why. Anticipating proximate causes for major price trends is only speculation. Gold was well into a major upswing before the dot-com bust, 9/11, ultra-low interest rates, the housing bubble and mortgage-backed securities debacle, and the 2008 credit crash. These headlines of course fueled a bull trend that was already well underway. At the end of the day, price makes news and the headlines follow. The obvious lesson is that all markets, including gold, discount future events and that the development of prices in the absence of easily articulated causes must be respected." – John Hathaway, Tocqueville Capital Management Corporation

• "Time is the soul of money, the long-view — its immortality. Hard assets are forever, even when destroyed by the cataclysms of history. It is the outlook that perpetuated the most competent and powerful aristocracies in continental Europe, well up through World War I and, in certain prominent cases, beyond; it is the mindset that has sustained the most fiscally serious democratic republic in the Western world, that of Switzerland. . ." – Marcia Christoff-Kurapovna, the Mises Institute

• "Production is declining and this is going to put an enormous amount of pressure on prices down the road. If you look back to the 70s, 80s and 90s, in every of those decades the industry found at least one 50+ million ounce gold deposit, at least ten 30+ million ounce deposits and countless 5 to 10 million ounce deposits. But if you look at the last 15 years, we found no 50 million ounce deposit, no 30 million ounce deposit and only very few 15 million ounce deposits. So where are those great big deposits we found in the past? How are they going to be replaced? We don’t know. We do not have those ore bodies in sight." – Pierre Lassonde, Franco-Nevada

• "Most major stock markets around the world are now more overbought than ever in history. Exponential moves of this nature can extend but when it turns, the move down is likely to come out of the blue, like in 1987, and be very fast and extremely punishing. Thus, the decision is really easy. The risk of holding bubble assets like stocks, bonds and property is now at a historical extreme. The easy and correct contrarian investment is to hold gold (and some silver). This will not only save investors from total wealth destruction but also create incredible opportunities to buy bombed out assets with the gold at 3 cents on the dollar. Investors must not miss this opportunity of a lifetime." – Egon von Greyerz, Matterhorn Asset Management


Disclaimer - Opinions expressed on the website do not constitute an offer to buy or sell, or the solicitation of an offer to buy or sell any precious metals product, nor should they be viewed in any way as investment advice or advice to buy, sell or hold. USAGOLD, Inc. recommends the purchase of physical precious metals for asset-preservation purposes, not speculation. Utilization of these opinions for speculative purposes is neither suggested nor advised. Commentary is strictly for educational purposes, and as such USAGOLD does not warrant or guarantee the the accuracy, timeliness or completeness of the information found here.