The Federal Reserve recognizes that market forces have finally begun to overpower the financial repression that has forced interest rates lower. To keep these powerful market forces at bay, it has reacted with gradual interest rate increases and a lot of jawboning, hoping that federal revenue grows rapidly enough to keep the Solvency Ratio from reaching the Tipping Point. But the Federal Reserve is “behind the curve”.
I remember this phrase very well from the 1970s. Interest rates kept rising, but the Federal Reserve never caught up with the worsening inflation until Paul Volcker became Federal Reserve chairman. He raised interest rates high enough so that the real interest rate reached a record level to re-establish demand for the dollar, which slowed the rate at which its purchasing power was being eroded. That’s not going to happen this time around.
When Mr Volcker raised interest rates to those extremely high levels back in the late 1970s and early 1980s, the US was the world’s largest creditor nation. Now it is the world’s largest debtor nation, so the current Federal Reserve chairman, Jerome Powell, does not have the same options that were available to Mr Volcker. The federal government today is over-leveraged with a huge debt load. The Tipping Point would be reached in any Volcker-like attempt to foster demand for the dollar by raising interest rates to even normal levels, let alone record real interest rates. So what is the federal government going to do?
It is unlikely that the federal government will give up willingly its power to create currency and return to a Constitutional dollar, which is defined as 13.714 grains of fine gold. It will not cut back on government spending nor learn from the lessons of history. As a direct result of the federal government’s boundless propensity to spend the currency the banks create for it out of thin air, the dollar is on the same path taken many times by many countries that incurred economic collapse as a result of the currency’s collapse.
Forcing interest rates to artificially low levels and underreporting the true rate of inflation for decades together have kept the federal government’s Solvency Ratio under control. But abuse of financial principles and irresponsible self-indulgent behaviour does not last forever. There always are consequences.
The dollar will hyperinflate. Like every other fiat currency before it, the dollar will end in the fiat currency graveyard.
- Source, James Turk via FGMR
As the government’s debt grows, its interest expense burden grows too, unless interest rates decline enough to keep the amount of gross interest relatively stable, like occurred in the above table since the mid-1990s. But growth in debt without declining interest rates perforce must result in a rising interest expense burden. This outcome puts the currency on the road to hyperinflation.
The hyperinflation results from the same insidious process seen time and again. The government does not generate enough revenue to meet its spending aspirations, including the obligation to service its debt. Rather than cut back on spending, it issues more debt.
In normal circumstances, investors purchase the debt, but at some point, demand from investors is satiated. The government then relies upon the banking system to act as a backstop and purchase the debt not taken up by investors.[ix]
As one would expect, different outcomes result from these two different purchasers. Investors do not turn government debt into currency; only banks can do that. Central banks turn government debt into cash-currency, i.e., the paper banknotes that circulate hand-to-hand, which was manifested in the German hyperinflation.
Commercial banks create deposit-currency, which circulates by check, plastic cards, wire transfers and the like through the banking system. As the saying goes, banks create “dollars out of thin air”. Through the magic of bank accounting, a bank purchasing government debt credits the government’s checking account with newly created amounts of currency that the government then spends, which is the process that created the Argentine hyperinflation.
Regardless which of the two types of hyperinflation occurs, they both start when investors are unable or unwilling to purchase more government debt, which results in growing government reliance upon the banking system to give the government the newly created currency that it then spends. Whether cash-currency or deposit-currency, the banks turn government debt into currency the government needs to meet its expenses and keep its head above water, i.e., to maintain the appearance that the government is solvent.
In this way, the government, with the assistance of banks, creates a never-ending vicious cycle of currency debasement when it is borrowing just to meet its ongoing expenses, including paying interest on its ever-growing debt. As the debt grows, interest rates rise, resulting in a greater annual interest expense payment to lenders and an even larger annual deficit, which in turn requires more debt and higher interest rates, thereby repeating the cycle until it invariably spirals out of control in a hyperinflationary currency collapse.
Borrowing to meet operating expenses is never a good idea. A worse idea is borrowing to meet interest payments on existing debt. These bad ideas when applied to government finance are the worst result because government’s today control the process of creating currency. Consequently, they use banks to turn government debt into circulating currency, and when done without end, the government inevitably creates a vicious cycle during which everyone suffers because it leads to hyperinflation and the collapse of the currency.
Every useful good or service is subject to supply and demand, the interaction of which determines an item’s price. Any nation’s currency is no different, except the result of its supply/demand interaction is called purchasing power, not price.
So for example, if the supply of currency (i.e., the quantity of units in circulation) remains unchanged and demand for that currency falls, its purchasing power will also fall. Similarly, if the supply of currency increases while demand remains unchanged, its purchasing power will again fall. We today generally label this decline in purchasing power as “inflation”, which clearly can result from changes in the currency’s supply, demand or both.
If the currency’s purchasing power falls far enough and does so quickly, hyperinflation results. Two well-known examples are Germany in 1923 and Argentina in 2001. In the former, hyperinflation occurred because of a rapid increase in the quantity of marks, which then led to a collapse in demand for the currency.
In contrast, in Argentina the quantity of pesos declined because of bank failures and government imposed restrictions, which caused demand for the peso to decline even more rapidly than its supply. Hyperinflation again was the result.
From these examples we can see the overriding role that demand plays. In effect, hyperinflation is a “flight from currency”. Hyperinflation results when the demand for the currency collapses. Fearful for the loss of their purchasing power, fewer and fewer people want to hold the currency, so they spend it or exchange it increasingly quickly for other currencies, which brings us to the importance of the Tipping Point.
As the Tipping Point rises above 20% and approaches 30%, demand for the currency declines. This decline occurs because historical experience shows that the currency is on the road to hyperinflation. So to be cautious, watchful observers start selling the currency and thereby move their purchasing power into other currencies or other forms of wealth to seek safety. Some, like the authors of “Bankruptcy 1995”, sound the alarm, further contributing to the decline in demand for the currency.
When the Tipping Point exceeds 30%, recognition of the government’s financial stress begins to spread with the result that the decline in demand for the currency begins to accelerate. That acceleration creates the inevitable flight from currency and ultimately leads to the collapse of the currency and hyperinflation.
- Source, James Turk via fgmr
In 1992 a book entitled “Bankruptcy 1995: The Coming Collapse of America and How to Stop It” hit the nation by storm. Written by Harry Figgie, a prominent businessman who had built a Fortune 500 company, and Gerald Swanson, an economics professor with expertise in public finance, it forecast that the US federal government would go bankrupt in 1995 and default.
The default would arise from a currency[i] collapse. Each lender to the federal government might receive back the same number of dollars they had loaned, but those dollars would have considerably less purchasing power[ii], and possibly none at all, making them worthless. So US Treasury debt instruments would have little or no value because they are denominated in dollars, the purchasing power of which would be decimated by hyperinflation.
Obviously it hasn’t happened. Even though the dollar subsequently experienced some horrific swoons and its purchasing power continues to erode, it has endured, but we should not ignore this book’s conclusions.
Two Key Assumptions Underlying “Bankruptcy 1995”
The logic of the authors’ analysis was faultless, but it was built on two assumptions, one of which turned out to be wrong. The first correctly inferred that the federal government’s debt would continue to increase, which at the time they wrote it had done every year since 1969. This ignominious annual streak of new indebtedness remains unbroken to this day.
The incorrect assumption was that interest rates would remain high and even increase. This interest rate outcome would occur because of the federal government’s growing debt load. The authors naturally expected that lenders would require higher interest rates to compensate them as the risk of default grew as a direct result of the growing debt burden.
The authors did not, however, anticipate that the Federal Reserve would force interest rates to unnaturally low levels. They did not – nor did anyone else – expect to endure what we now call “financial repression”, but forcing interest rates lower was only part of the repression.
The federal government also had to convince the purchasers who bought its debt that everyone was getting a fair deal. In other words, not only did the federal government need to lower interest rates, it needed to make the inflation rate look low too.[iii] In this way, real interest rates – the nominal interest rate less the purported inflation rate – would show a positive return to the lender. After all, lenders expect as a matter of course to gain purchasing power when lending their dollars to compensate them for putting them at risk while foregoing until the future the purchasing power it represents.
Clearly, it was going to be a Herculean task to convince lenders – and indeed, the ‘market’ – that inflation was not as bad as people were experiencing from their everyday purchases. But it was a task that had to be undertaken to postpone the projected 1995 bankruptcy and currency collapse.
So the federal government formed the “Advisory Commission to Study the Consumer Price Index”. It of course concluded that inflation was not as bad as everyone believed. Even though the federal government in the early 1980s had already changed the calculation of the CPI to report an inflation rate that was lower than the true rate at which the purchasing power of the dollar was being eroded, it did so again[iv].
This pernicious sleight of hand by the government significantly distorted the means to perform accurate economic calculation with the result that for decades, precious accumulated capital earned from hard work has been misallocated and wasted on countless follies. What’s more, currency debasement has taken purchasing power out of the hands of savers and diminished the value of one’s wages. Even if the amount of the wage increased, “keeping up with inflation” requires cost of living adjustments above the CPI. [v]
The federal government’s fiddling with its calculation of the dollar’s inflation rate is without a doubt the biggest swindle of all-time. The result has been increasing friction across the US and throughout all levels of society. As Lenin correctly observed, to destroy society you simply debauch the currency.[vi]
I have presented this background information purposefully in order to ask the following question. What if “Bankruptcy 1995” was written twenty-five years too early?
The gold price has been in a rising uptrend from its low of $1050 in December 2015. This climb has occurred within a multi-year base during which gold has been accumulated because it was and still is undervalued. With gold’s breakout this year above $1300, its 2-year base should now be viewed as a launching pad that will take gold much higher in the months and years ahead as phase 2 inevitably morphs into phase 3. How much higher depends on what central banks do.
Right now central banks want more inflation, and they are getting it. In 2017 crude oil – the price of which is a reliable forecast of rising inflation – rose by 12.5%. This year it has already risen 6.4%.
Central banks are actively pursuing their more-inflation goal with a variety of policies that weaken the purchasing power of the national currency each bank is managing. So to protect their wealth from the ravages of inflation and other policies that debase the currency people need to hold and use in everyday commerce, they protect their purchasing power by buying gold and silver, which as history has demonstrated time and again is the logical response.
If central banks continue their policies that debase national currencies, then expect a much higher gold price. But again, how much higher depends on how badly every central bank eats away at the purchasing power of each national currency.
It also depends on one other basic element. What is gold’s fair value?
I use mathematical models based on historical results to calculate gold’s value. These models are explained in my latest book, “The Money Bubble: What To Do Before It Pops”. Using these models we can calculate that gold’s fair value presently is about $11,000 per ounce.
An 8-fold increase in the gold price to reach that level may sound shocking. However, it is quite modest when compared to gold’s 24-fold increase from $35 to $850 in gold’s 1968-1980 bull market. That historic price rise is also greater than the 10-fold increase if we were to use $1050 as the base of our calculation for that $11,000 calculation of gold’s fair value.
In Congressional testimony in 1912, JP Morgan, the leading financier of the day, said: “Money is gold, and nothing else.” From his insight we can conclude that the dollar is a money-substitute that circulates in place of money, which is gold. The ‘Money Bubble’ pops when gold reaches phase 3.
The shorts are struggling to try finding physical silver to deliver. The smart money is asking the shorts to turn the short’s paper promises into the real thing, which is a trend that I expect will continue throughout this year, not only because of inflation but also as a result of rising counterparty risk because banks are sitting on a growing stack of bad debts.
As a consequence, both gold and silver will continue much as before. The prices of both metals will trend higher as the year progresses. Importantly, the uptrend will accelerate as the group of smart money buyers accumulating the metal gets bigger as more and more people begin to understand that the debasement of the dollar is accelerating.
The second important point, Eric, is what happened after the CPI was released. Both gold and silver climbed back after the big hit they took on the release of the CPI.
After the CPI was released, the price manipulators took the metals lower to clean out the sell stops under the market looking for more physical metal. To their surprise, the backwardation didn’t disappear. It got worse. And then both precious metals completed a very bullish outside reversal day.
So the shorts are in real trouble. The central bank price manipulators who have been shorting gold and silver to keep prices under their control are contending with a toxic mix of a collapsing dollar and rising inflation. Both of these reasons mean that the precious metals are destined to continue climbing higher this year.”
The first is the prevailing sentiment. Before the CPI was released, commentary on the precious metals took two different roads.
If the CPI was worse than expected, the Fed would raise interest rates which would be bad news for gold and silver. If however, the government’s inflation report came in less than expected, it would be bad news for gold and silver because no one would need to buy the metal to protect one’s purchasing power from inflation.
So there you have it. Conventional wisdom had it that gold could not win. No matter what CPI was reported, gold and silver would get hit, and they did. But here’s the important message from this conventional wisdom.
When sentiment gets so bad that there is no reason to buy an asset with a 5000-year proven track record of protecting one’s wealth, you know the price of that asset is extremely undervalued and ready to move higher. When it comes to markets, conventional wisdom is usually wrong, and today was not an exception.
"Today was a very important day for gold and silver, Eric. The reaction in their prices to the CPI released earlier today provides us with some very valuable insight into the state of the precious metals market. And this insight is bullish for both precious metals…
The CPI number came in higher than expected, which shows that even by the government’s own calculation, inflation is worsening. And we all know that inflation is a lot higher than what the government reports, so the purchasing power of the dollar is being stealthily eroded even more than what is reported.
But there are two things that I found to be the really interesting about this CPI report. "
