Midyear is a good time to take a fresh broad brush view of the fiscal/monetary situation.
The capital markets have absorbed dramatically higher interest rates, a declining money supply, and a much more challenging lending environment. The “soft landing” from the bubble-like conditions in the financial market that seemed like a remote hope now appears to be a possibility. The “bubble”, while not in the general economy, was reflected in higher oil prices, home prices, stock and bond prices, cryptocurrencies, meme stocks, SPACs and other inflated asset prices. Most of these “asset classes” have been shaken down, and some equity investors are looking across the current peaks in interest rate to a more sedate valley beyond. While interest rates, sponsored by Central Banks around the world, are a great deal higher than they were, with most of the anticipated movement now in the rear view mirror, we believe that the price for over twenty years of fiscal/monetary promiscuity is yet to be paid.
The stock market was firm in June, as equity investors seemed willing to believe in the possibility of a “soft landing”, even as the Fed continues to tighten. Also anticipated is easier money down the road, presumably after the inflation genie has been slayed. Our readers know that we like gold mining stocks for long term investment purposes. While gold bullion and the gold miners have been attractive investments since last fall, the last several months have taken back our portfolio gains of early ’23.
Inflation has (temporarily, we believe) come down to about 4% year to year (a little more than we expected) and short-term interest rates have moved back up to about 5% (not high enough to really squash inflation). With inflation slowing, we believe the economy is much weaker than the Fed portrays. Since the Fed is once again reacting too late, the swing back to easy money will be more dramatic than is now expected. Inflation will accelerate from somewhere around this level within a matter of months, driving inflation and gold related assets upward once again.
The Fed’s accomodative stance, to support a debt burdened economy, will be necessary as far as the eye can see. The Fed will control the situation until they cannot, and the world will then have to finally take responsibility for the decades of fiscal/monetary promiscuity.
In support of that statement: Interest payment last year on the US Debt was $475B (9.7% of ’22 US Revenues) and will be up another 35% this year to about $641B. The current year’s operating deficit of $2T, financed at an average of 4%, will add $80B and $3.7 trillion of existing bills (one year or less), must be rolled at about 300 basis points higher, costing an additional $100B. This new total of $180B will take the interest expense to about $820B, which is way above the $592B cost of Medicaid and approximates what we spend on Defense. The long-term picture is yet more disturbing. The Government Accountability Office, assuming a 4.2% average interest rate, assuming no wars, no recessions or worse, no pandemics or such, projects that interest expense will eat up 48.5% of US Revenues in 2051 and 141.4% by 2096.
This situation can obviously not persist. There will be a default on the debt, around the world, either by outright default (“so sorry”), or inflating it away with the continued issuance of increasingly large amounts of unbacked paper currency. This is why Central Banks around the word continue to diversify their reserves away from fiat currencies, in particular the US Dollar. Since 2009 they have bought increasing amounts of gold bullion, most recently absorbing over 1,000 tons per year, about 30% of worldwide production. Watch what they do, not what they say!
Roger Lipton