October 10, 2020
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Gold Sends a Warning

Gold Sends a Warning

Gold is a much maligned and misunderstood metal that serves simply as a store of value. It has been said that an ounce of gold will always buy a very expensive suit. Since the beginning of Greece and Rome, nations have used it as a means of exchange. Nations anchored their currency to gold in order to impose fiscal discipline on governments and keep prices stable in the economy. It also rendered faith as the currency. Simply stated, the metal supported stable prices and later backed script in circulation. Article 1, Section 10, of the U.S. Constitution directs the use of gold and silver as the means of coinage. The founding fathers had lived through high inflation during the revolution and understood the need for sound money. The phrase, “it ain’t worth a continental (dollar),” came from this age. We left a true gold standard during the Civil War and reestablished it in 1879. We left again in 1933 and in 1971; Nixon allowed the dollar to float. The United States found it impossible to wage a war on poverty and Vietnam while honoring its gold obligations to foreign lenders. Higher prices have been the result. The most recent move in the price of gold is, in part, clearly correlated to the increase of the national debt, which has steadily increased since the year 2000. Democrats and Republicans share equal responsibility.

Doubt or reservations have been placed into the market as to whether or not this debt will affect the future prosperity and economic standing of the United States. A reasonable person must understand that the addition of debt and the service needed on the interest alone, will produce some type of financial reckoning in the future. No one is certain how this will occur or what will prompt it. Let us be candid. Over the ages, no nation can print money to achieve prosperity. In reality, the opposite has occurred. 

History is littered with the unmarked graves of discarded currencies whose rulers have promised prosperity, but delivered ruin. The Roman Empire met its demise, in part, from the debasement of its currency. France, twice during the 18th century, met with financial disaster as its leaders went to the printing press. Following the reign of terror, Napoleon reestablished the gold standard. In 1803, he sold Louisiana to the United States for $15 million in gold in order to finance his wars in Europe, without experiencing inflation. Germany in the Weimar Republic, experienced hyperinflation, until anchoring its currency to gold. Modern day Zimbabwe, Venezuela and Argentina have all lost control of their currencies.  

The United States has been given a global “hall pass” by the capital markets, since the dollar is the world’s reserve currency. Throughout this current crisis, the dollar has remained strong despite the explosion of the national debt caused by the nearly $5 trillion in promised support of the financial and economic system by Congress and the Federal Reserve. The American dollar is only strong because the world has no other alternative. There is also implied trust that the United States will repay its debt, with interest.

But how long can this last? It is possible to expand the national debt to $40 or $50 trillion. The ultimate check in the system is how long will investors lend America money for ten years and receive 1.00% interest? If the world demands 10%, be assured there will be a domestic financial adjustment. The United States government will have to raise taxes, sell assets or both. 

As Jude Wanniski stated, “The market is the most accurately programmed computer on the planet, the closest expression of the mind of the electorate itself.” While this quotation applied to the stock market discounting the future earnings of stocks, the gold market discounts other potential future actions: fear, inflation or loss of confidence in the dollar. The chart below shows the relationship between the national debt and the price of gold.

RISE IN GOLD CORRELATED TO THE NATIONAL DEBT OF THE UNITED STATES

DateNational Debt (trillions)Gold (per oz.)


06/30/20$26.477$1,780.10


09/30/1922.7191,471.50


09/30/1821.5161,188.40


09/30/1720.2451,279.40


09/30/1619.5731,315.90


09/30/1518.1501,115.30


09/30/1417.7811,208.70


09/30/1316.7381,327.90


09/30/1216.0661,771.10


09/30/1114.7901,624.80


09/30/1013.5611,309.50


09/30/0911.9091,007.70


09/30/089.945870.00


09/30/079.007743.10


09/30/068.506598.70


09/30/057.932468.70


09/30/047.379418.40


09/30/036.783384.70


09/30/026.228323.80


09/30/015.807291.55


09/30/00$5.674$273.80


Source: https://treasurydirect.gov/govt/reports/pd/pd_debttothepenny.htm

September 30th denotes the end of the federal fiscal year. What is gold’s warning to the global market? The metal is a market-driven commodity that is increasing in value as the liabilities of the United States expand. As nearly 20% of the national debt is held by the Federal Reserve on its rapidly expanding balance sheet, concern is expressed that should an exchange of dollars to gold be required, the amount of gold needed to fulfill that transaction will be much higher. The gold market may be expressing concern that the Federal Reserve has now become permanently involved in the United States’ economy. In October 2018, the Fed Chairman Jerome Powell stated that quantitative tightening was on “auto pilot” and the Federal Reserve would raise interest rates in 2019. Combined with the Trump Administration’s bellicose trade and military talk on China, the markets tanked. Chairman Powell walked back his comments around Christmas and the White House followed with assuaging comments on trade. Only these combined actions righted the markets by year end. Believing that the Federal Reserve can put its “bazooka” back in the tool box after this current crisis may only be wishful thinking.

Edwin Meese III, Ronald Reagan’s Attorney General, stated that, “deficits are an abstract concept in Washington.” The gold market is weighing in on the cumulative deficits of the United States. The world has watched, as well. Germany has completed its repatriation of gold from New York and Paris. The Indian Central bank has purchased several hundred tons of gold. Russia and China have increased their gold stores. Should modern economic theory be believed, then the metal is meaningless, renders little value and is only kept by central banks because of tradition. The markets are wise to ignore such theory. Gold is ultimately a gauge on the dashboard of the global economy. It is sending a strong message and deserves the world’s attention.

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Written by
David Breuhan