The following article appeared in Bloomberg on June 4th. You can not cure a problem that was brought on by too much debt by spending more. This is not a political statement but simply an economic reality. If you were a home buyer making $50,000 per year and you’re in foreclosure and headed into bankruptcy, would you go out and borrow more money? Would you do it thinking, “hey maybe this will work because I’ll be able to spend more now?”
Many in the mainstream media think it’s okay to continue to borrow this way because it stimulates the economy. Then, what happens when the stimulus (debt) stops? What happens when (as this article suggests) rates have to rise in order to attract the required foreign debt buyers? As Bill Gross points out, at some point economic growth simply won’t be enough to support the level of debt. Our answer? Keep on borrowing more money.
This is one of the primary reasons gold is and will continue to rise in the years ahead. There is no debt attached to gold. It is seen as a flight to quality and the one currency immune from the actions of central banks. Remember skepticism in a bull market is a good thing. As Bill Fleckenstein points out:
“What’s remarkable to me is that there were very few people that openly discussed the consequences of the absurd equity bubble we had, and the even more absurd and obvious real estate bubble. Yet there are quite a large number of people who are sure gold is in a bubble. I think the people who say that have absolutely no grasp of macro-economic dynamics, and if they missed the real estate bubble they showed you that they don’t even understand the simplest things.”
U.S.’s $13 Trillion Debt
By Garfield Reynolds and Wes Goodman - Jun 4, 2010Poised to Overtake GDP: Chart of Day
President Barack Obama is poised to increase the U.S. debt to a level that exceeds the value of the nation’s annual economic output, a step toward what Bill Gross called a “debt super cycle.”
U.S. Debt Poised To Exceed Annual Economic Output
The CHART OF THE DAY tracks U.S. gross domestic product and the government’s total debt, which rose past $13 trillion for the first time this month. The amount owed will surpass GDP in 2012, based on forecasts by the International Monetary Fund. The lower panel shows U.S. annual GDP growth as tracked by the IMF, which projects the world’s largest economy to expand at a slower pace than the 3.2 percent average during the past five decades.
“Over the long term, interest rates on government debt will likely have to rise to attract investors,” said Hiroki Shimazu, a market economist in Tokyo at Nikko Cordial Securities Inc., a unit of Japan’s third-largest publicly traded bank. “That will be a big burden on the government and the people.”
Gross, who runs the world’s largest mutual fund at Pacific Investment Management Co. in Newport Beach, California, said in his June outlook report that “the debt super cycle trend” suggests U.S. economic growth won’t be enough to support the borrowings “if real interest rates were ever to go up instead of down.”
Dan Fuss, who manages the Loomis Sayles Bond Fund, which beat 94 percent of competitors the past year, said last week that he sold all of his Treasury bonds because of prospects interest rates will rise as the U.S. borrows unprecedented amounts. Obama is borrowing record amounts to fund spending programs to help the economy recover from its longest recession since the 1930s.
“The incremental borrower of funds in the U.S. capital markets is rapidly becoming the U.S. Treasury,” Boston-based Fuss said. “Do you really want to buy the debt of the biggest issuer?”
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Hey Mike,
What percentage of a person’s total portfolio do you figure they could afford to have in gold? I know that you’re a stock and bond man too, but I’m curious about your thoughts on the percentage allocation of the yellow stuff, for instance.
Cheers,
Andrew
Interesting graph, since a lot of this debt is not being used to increase production, but is simply redistributing resources.
However, for the debt to go down (for the US govt to run a surplus), non US-govt will have to run a deficit. The US govt will have to suck in more dollars than it spends or borrows. Who would you see picking up the slack?
I think as far as a decency of life goes, increased exports would improve employment prospects, might greatly improve the morale of the country and would help bring in those dollars, but the US needs to find something to specialize in again besides financial weapons of mass destruction.
I find the debt issue really interesting since it is a big trap for the creditors. The thing about the debt is that it is a real resource redistribution from the creditors to the debtors. The US gave China and Japan IOUs, and got real goods in return. Sure the debt might be huge, but the burden is really on China, Japan, etc… to ensure that their dollars don’t become worthless.
If they started liquidating, a couple of things would happen: First, USD would plummet, but this hurts the creditors, not the debtor. Second, a much lower USD would significantly boost employment, so that helps out on the political side of things. This plays right into the hands of the government.
Of course, once the avalanche starts, good luck to them to continue to get others to accept their IOUs in return for real goods :S
Hey Andrew,
That is a great question. I will give you my “cocktail party answer” I always say that 5-10% for portfolio insurance. This is not for inflation or deflation insurance but rather insurance against governments acting (printing) irresponsibly in terms of their balance sheets. I wouldn’t recommend more than that unless there was a deeper understanding as to the interrelationships of gold and other currencies of the world. It would be nice to actually have a conversation one of these days with you and Kevin to discuss these sorts of topics. I always appreciate both of your views. Thanks for stopping by. Mike
Hi Kevin,
Personally, I think it comes down to admitting the federal government needs to shrink drastically. Currently there are 2 million federal employees. Thats 2 for every 15 people I think. I agree with you that increased exports would make significant improvements across the board.
I believe China is already beginning to diversify outside of the US Dollar. Of course they need to watch how this affects their exports. I was in an investment committee meeting yesterday and someone mentioned that China’s exports to the US are decreasing significantly. I see this as more of a threat to the US than China, especially long term. However, the major currencies Dollar, Euro and Yen and now Renminbi are so interlinked that I don’t see how either can simply wholly abandon the other.
I think there will be some surprises but life will go on, of course. Thanks for the well thought out comments. Mike