Sovereign Debt Crisis and the Rise of Gold

Jul 14, 2022

Sovereign Debt Crisis Slams the World

Why gold prices are likely to explode higher over the next three years...

Inflation is exposing the central bankers of the world.

Over the past fourteen years, and in response to the Great Recession in 2008, the major central banks of the world expanded their balance sheets by roughly 10X.

In 2008, the Federal Reserve balance sheet was $850 billion. Today our balance sheet hovers more than ten times higher, near $9 trillion. These actions unnaturally pinned interest rates at close to 0% for much of the last 14 years.

This manipulation has aided and abetted governments around the globe to run massive deficits.

U.S. National debt in 2008 stood at $9.4 trillion.

Today, our national debt stands more than three times higher at $30.4 trillion.

But it’s not just the United States. This has been a global phenomenon.

Milton Friedman taught us that “inflation is always a result of an expansion in the money supply without an equal expansion in productivity.”

We covered this in our Special Report: On Thin Ice which we released in January.

M1 money supply, which represents the amount of currency in circulation, was $1.4 trillion in 2007. Today, the M1 money supply sits at $20.6 trillion. An increase of 1328%. [1]

Global debt in 2007 was $142 trillion. Today it stands at $303 trillion. An increase of 113%. [2]

Global GDP has not matched this monetary expansion. In 2008, global GDP was $64 trillion. Today it stands at $96 trillion. An increase of only 50%. [3]

If you are wondering why inflation is raging around the world, look no further than the statistics above. The global supply of money and credit has increased multiples of global productivity since the financial crisis fourteen years ago.

Rampant inflation is the result.

The Great Devaluation predicted that central banks would lose control of the monetary system. We believe this is playing out in real time.

For evidence, we provide the following grid:

Source: https://twitter.com/charliebilello/status/1547218698146119680?s=10&t=q3Rpr7nP5BkQjGyXEafmcA, https://countryeconomy.com/key-rates

Notice that inflation rates are dramatically higher than the interest rates offered by central banks.

When looking at the above data, we must remember that the goal of the central bank is to maintain and preserve the credibility of their currencies. Central banks around the world have been negligent in their duty.

Our financial system has been rigged.

The results have been completely distorted and we can no longer trust manipulated bond values. Central banks have accounted for a large percentage of bond demand. This is what bond buying programs do. They make true price discovery impossible.

We recognize that the Federal Reserve keeps promising us that inflation will come down. Their promises are beginning to feel like Charlie Brown kicking the air while Lucy pulls the football.

At some point, especially as the Fed seems determined to crush demand with another policy error by tightening into a recession, inflation will come down. But you have to ask yourself a very important question.

Do you want to lend to the U.S. government for 10 years to receive a return of 3% per year when inflation is running three times higher than that?

Even if inflation comes back down over time, isn’t it far more likely that it will come down to levels closer to 4% to 5%?

Ken Rogoff, former IMF economist and author of the book, This Time Is Different, calls this “financial repression”. It's when governments allow inflation to run higher than the yield offered on their debt.

It is why we believe something bad is about to happen.

U.S. debt is viewed as the safest asset in the world. Can this continue to be the case?

The amount of losses incurred on a global scale as inflation erodes away the value of our treasury bonds is impossible to figure. The entire global monetary system relies on treasuries.

This is why the Federal Reserve will raise interest rates. They must.

As the markets wake up to that reality, we can expect greater and greater pressure on stocks and bonds. The S&P 500 is down 22% on the year. TLT, the ETF that measures the 20-year treasury bond, is down 20% on the year.

These losses signal the death of the 60/40 portfolio, and what the Return to Real is all about.

Yesterday’s CPI print was 9.1%, the highest since 1981.

Many are suggesting that Jerome Powell will need to be like Paul Volcker and do everything in his power to raise interest rates until he stops inflation. Volcker famously crushed inflation in 1981 by raising interest rates to 20%.

This is wishful thinking. There is no chance that Powell can achieve a similar result.

The Fed Funds rate in 1981 was 15%. Today it’s only 1.65%.

In 1981, our country’s debt/GDP ratio was only 31%. Today, our debt/GDP ratio is a whopping 127%. [4] [5]

This makes raising rates an impossibility for any length of time. Higher rates, coupled with a colossal $30 trillion debt load only increases our borrowing costs, putting the U.S. into a deeper fiscal spiral. So while financial pundits will be screaming that the Fed needs to raise rates 100 basis points in July, the reality is that if they do they most likely will need to immediately pause thereafter, and then cut them from there.

This is why investors have no place to hide. Except, that is, in gold. (More on this in a moment)

In the short term, Powell must do something. We can expect a big rate hike at the end of July. This is what is causing stocks and bonds to get hammered this year. The Fed is obviously behind the curve and must raise rates. This action has likely already put us into recession.

We believe that Mike Wilson of Morgan Stanley has it right and that the S&P 500 will likely drop another 10-15% from here to the 3400 level before the end of August. [6]

The next rate hike in July will likely be followed by a big “pause” in September.

The reason why is recession.

One of the most consistent leading indicators for recession is the "inverted yield curve". Yield curve inversion has virtually always predicted recessions, with a 67% likelihood within one year of inverting, and a 98% likelihood within two years.

This means recession is a near certainty.

The yield curve has inverted three times in the last 22 years. In February of 2000, in December of 2005, and in March of this year.

The '00 yield curve inversion was followed by a recession in the U.S. that began in March '01 and lasted through November that year.

The '05 yield curve inversion was followed by a recession that began two years later in December '07 and lasted through June '09. [7]

And this is why you may want to back up the truck and buy gold.

Pay particular attention to what occurs in the 36 months following the first yield curve inversion.

Notice that the S&P 500 dropped 39% in the three years following the first yield curve inversion in '00. Notice again, in the three years following the '05 inversion, the S&P 500 dropped 31%. This doesn't bode well for equities in the coming years.

Gold, conversely, in the three years following yield curve inversions rose significantly, up to 35% after the inversion in '00, and up 78% in the three years following the inversion in '05.

There are a lot of people looking at gold today and wondering what’s going on. Gold seems very quiet in the midst of recent volatility. As the dollar has strengthened, gold prices have fallen. They’ve just fallen a lot less than stock and bond prices.

Year to date, gold is down only 4%.

For all of the reasons mentioned above, I believe this is the greatest buying opportunity I've ever seen. It's why I've added another 50 ounces in physical gold to my personal portfolio this week.

You see, I am very aware of how gold has performed historically. Gold has been one of the greatest assets to own when our country goes into recession. Particularly today, and based on our understanding of the yield curve inversion, I believe that gold prices will rise significantly between now and March '25.

If history is our guide, and with a starting gold price of $1925 (March '22), a 35% rise similar to '00 would mean a gold price of $2598 by March '25.

If we were to see a rise in gold similar to the three years following '05 of 78%, the price of gold in March '25 would equate to $3426.

This is why I am incredibly bullish on gold. Spot gold prices traded at $1700 today. That’s a discount of 12% from where gold prices were in March of this year.

Believe it or not, it gets even better when looking longer term.

In the five years following a yield curve inversion, gold prices have been incredibly higher.

In February of '07, the price of gold hit $675 per ounce. An increase of 140% in just five years.

In December '12, the price of gold hit $1700. An increase of 245% in just five years. [8]

I have found that history may not repeat itself, but it sure does rhyme. Yield curve inversions signal recessions, and recessions signal much higher gold prices can be expected in the years to follow.

Should gold prices increase 200% by the year 2027, the price of gold would be $5775 per ounce.

This is why long-term investors may want to consider adding gold, and doing so now.

Best,

Adam Baratta

Editor-in-Chief

Brentwood Research