Dear member,
Debt across the developed world is at its highest level since the end of WWII (as a percentage of GDP).
Zerohedge reported last week that, since 2008, "the G7 (nations) have added around $18tn of consolidated debt to a record $140 trillion, relative to only $1tn of nominal GDP activity and nearly $5tn of G7 central bank balance sheet expansion (Fed+BoJ+BoE+ECB). In other words, over the past five years in the developed world, it took $18 dollars of debt (of which 28% was provided by central banks) to generate $1 of growth."
The only reason this incredible house of cards, also known as the global economy, has not yet imploded is due to one single fact:
sustained ultra-low interest rates for the last decade.
If interest rates rise even another 150 basis points, it would make servicing debt (for many countries, corporations and households) unsustainable and force nations into insolvency. That is not an assumption, but a fact.
The Defining Story of 2013
The most important story in finance during 2013 has been rising interest rates; the rate on the 10 Year Treasury Note, in particular, is of great importance as most interest rates, including mortgage rates, are adjusted to it. At the most basic level, interest rates represent the cost of money. And if there's one economy that can't afford expensive money, it's the US.
US 10 Year Treasury Note - 1 Year Chart
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chart source: Yahoo
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While most remain preoccupied with the countdown to the Fed's FOMC meeting this coming week, or the drama unfolding in Syria, there's a major financial story developing that could change the economic outlook for the next decade.
At the end of fiscal year 2000, US national debt totalled $5.67 trillion. The US government paid $361.9 billion in interest that year.
Jump forward 12 years to the end of fiscal year 2012. US national debt totalled $16.06 trillion and its government paid $359.7 billion in interest - just two billion shy of its 2000 interest bill.
This is quite impressive, really... the US was able to triple its national debt in 12 years, but pay almost exactly the same amount in interest. This clearly highlights the importance of ultra-low interest rates. The US is fundamentally dependant upon record low rates.
- In 2000, the average interest rates on total interest-bearing debt was 6.599%
- In 2012, the average interest rates on total interest-bearing debt was 2.647%
Source: U.S. Department of the Treasury, Bureau of the Public Debt statistics
As the bond market continues to revolt, demanding higher interest for the tens of billions in debt the US issues each month, a very serious and real threat is emerging.
Simple Math Shows Unavoidable Outcome
6% of $16 trillion is $960 billion. While it's unlikely the Fed will allow interest rates to hit 2000 levels anytime soon, it's not unrealistic to assume that 6% interest will return eventually (it is close to the historical average after all).
If Bernanke follows through on tapering threats, which will throw the bond market to the wolves, there is a good chance the 10 Year will continue to rise, potentially proving catastrophic to the bond market which is already on shaky ground.
Also, remember that the US national debt is flirting with $17 trillion. Even rates of 4%, at $18 or $19 trillion in national debt, would swallow up more than a quarter of all tax revenues generated in a given year.
The threat of rising interest rates holds the potential to usher in a crisis of confidence that could lead to a collapse in the bond market, and the removal of the USD as the world reserve currency. This would be the end game. This is the destabilizing event the US refuses to prepare for. If the Fed announces that it will taper substantially at its highly anticipated FOMC meeting next week, September 17th and 18th, it will accelerate the rise in interest rates and the collapse of the bond market.
* This would be very beneficial for gold.
For these reasons, we believe the Fed will opt not to taper, or to only taper a small amount (10 to 15% -
click here for past report on the subject).
10 Year Treasury Note - 13 Year Chart
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chart source: Yahoo
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Gold Wins, Either Way
The impact of rising or falling interest rates on gold will be positive, either way. How is that so?
If the Fed steps away from the bond market, the USD will rally for the short-term, initially hurting gold; but, as interest rates soar, investors will soon realize the US has accumulated too much debt and that its consumer-based economy is too weak to repay the debt. This could create a full-blown liquidation event in the bond market that not even the Federal Reserve can stop.
Best Case Scenario
Let's assume the bond markets avoid a destabilizing event initially; the consequences of higher interest rates and continued weak economic growth would immediately deploy massive deflation across the economy. It would also force the US government to raise the debt ceiling even faster to stay solvent, as higher interest rates would leave less money for Medicare and Medicaid, which in turn would only increase debt levels. Therefore, tapering could have a chain reaction that ultimately leads to a mass exodus of US debt and US dollars by the international community.
While it's impossible to cover every angle in these unprecedented economic times, especially with a Fed leader as innovative and daring as Bernanke, higher interest rates mean higher payments and a greater percentage of tax revenue going straight to creditors.
If you don't think the US debt ceiling is going higher, think again.
The debt ceiling crisis of 2011 was a spectacle of political drama. Expect 2013 to be very similar as the US government will likely need to ask for a greater increase. $20 trillion debt ceiling anyone?
On August 29th 2013, the US Department of Commerce reported that the current-dollar GDP increased 3.2%, or $132.6 billion, in the second quarter of 2013 to an annual level of $16.66 trillion. Remember that this figure may be revised.
The US national debt, not including future unfunded liabilities, totalled $16.93 trillion on September 12th 2013.
As of August 31st 2013, US debt to GDP was 104.5%. With any downward revision in GDP and continued increase in debt accumulation, there is a good chance the ratio will hit 110% by early 2014.
Historic Track Record
Throughout history, when a nation's debt level exceeds its annual GDP, by breaching the 100% debt to GDP ratio, it becomes very difficult (and almost impossible) for those nations to avoid a banking crisis or sovereign debt crisis. The sheer amount of debt becomes painful to overcome. Default or hyperinflation are the two leading results as politicians rarely have the gusto to make the tough decisions and reign in spending. They typically view such fiscal responsibility as political suicide.
Piling on more debt each and every year to sustain, not grow, is a sign economic calamity will be forthcoming and is almost always tied to extensive social programs. The US has entered the danger zone of debt greater than 100% to GDP, and shows no signs of turning back. Whether or not the Fed reduces its current $85 billion monthly bond and mortgage-backed securities buying program is somewhat irrelevant now. The debt is becoming a runaway train that builds momentum and speed with each passing day. It will force savvy investors out of US dollars and into hard assets, such as gold.
All the best with your investments,