SEMI-Monthly Fiscal/Monetary Update – The Beat Goes On – Ignore the Risks at Your Peril

Increasing governmental annual operating deficits & cumulative debt, a slow economy accompanied by ongoing very low interest rates, are all supportive of an increasing price of gold. This is not necessarily true over a month or two, or even a number of years but over a longer period of time it is predictable. Since 2000, when all of the above trends became well established, the price of gold has gone from $300/oz. to over $1300/oz., outperforming almost every other asset class.

The economy continues to be sluggish, even though a phalanx of optimistic economists predict that GDP growth is just about to improve. We doubt it, and the revisions for the current September quarter are coming through lower rather than higher. GDP growth in the fiscal year ending 9/30/17 will no doubt be much closer to 2% than 3%. This has been the case for almost a decade, and it continues to be “on the come”.

Meanwhile, the cumulative U.S. debt is now comfortably over $20 trillion, with the 9/30/17 yearly deficit about to exceed $700 billion (we don’t know by how much). There is no question that the deficit in Y/E 9/30/18 will be higher, probably close to $1 trillion, especially with higher defense spending, health insurance subsidies, and the start of infrastructure spending. There have unfortunately been a large number of “shovel ready” projects created by the recent storms, likely to cost over $100B.

Some observers suggest that higher GDP growth will quickly solve the debt problem. The newly proposed budget U.S. federal will no doubt involve a higher short term deficit, but would hopefully ignite the growth, reduce or eliminate the annual deficits, even pay down the cumulative debt. This “dynamic scoring” is a complex subject, but Steve Mnuchin, Treasury Secretary, recently provided guidance. He said that 3% growth, up from the current 2%, would generate $2 trillion of extra federal tax revenues over 10 years. Unfortunately, that is only an average of $200B annually, only a modest down payment on the current $1T run rate. Conclusion: The debt and deficit Beat Goes On (increasing the burden on future growth).

As a sign of the ongoing absurdity, and danger, taking place in the monetary world: a Wall Street Journal article last week talked about Alibaba Group Holding, Ltd having created the world’s largest money  market fund, now at $218B, up from $124B only six months earlier. The rapid growth is no doubt a function of the very attractive seven day yield of 4.02%, up from 2.3% a year earlier. The disconnect is that one-year Chinese bank deposits only yield 1.5% and even 10 year Chinese bonds earn only 3.6%. The extraordinary 4.02% yield has been generated by investing in “financial instruments with longer maturities”, no doubt of lesser quality and less liquid than a “money market” model would suggest.  It was a big deal ten years ago when a US money market fund couldn’t redeem deposits at the “buck” model due to illiquidity. In China today, and around the world, investors continue to “reach for yield”, which predictably will end badly.