Volcano of Debt

Got gold to ride out the magma...?

The FED is going to make this sucker blow, writes Dan Denning at Bonner and Partners.

That's what I found myself thinking, looking out of my room at the sunrise on Mount Taranaki.

I sipped a cup of coffee, waiting for an early morning conference call with the Bonner & Partners analysts back in Florida.

I'm in New Plymouth, on the west coast of the North Island of New Zealand. The bolthole search continues.

Last week, I met up with readers in small towns north of Auckland. I'll tell you what they told me and show you some pictures of the stunning coastline.

Mount Taranaki, which tops out at 8,261 feet, last erupted in 1854. It reminds me of Mount Vesuvius, which erupted in AD79 and buried Pompeii and Herculaneum.

We know about that eruption because Pliny the Younger wrote about it. And he wrote about it because his uncle, Pliny the Elder, was in the Bay of Naples when the volcano erupted and later died (though history is not clear how).

Moral of the story: Let sleeping volcanoes lie.

Bad news for America: The national debt has gone over $22 trillion. The US Department of the Treasury released the news on Tuesday, a day that will live in infamy.

Actually, no one will probably remember or care, at least not until much later.

But the debt builds under the economy like a magma chamber under a volcano. Another $2 trillion has been added to the debt since Donald Trump became president. Far from draining the swamp, he's clogging it with even more IOUs. Who will pay them?

More disturbing news from Washington: The Federal Reserve is NOT going to normalize interest rates nor is the Fed going to shrink its balance sheet in 2019, as it planned.

But on top of that, it's also going to consider making quantitative easing (QE) a permanent feature of its policy toolkit (and not just an emergency measure). What does that mean?

We are in a perpetual monetary emergency now. The public debt could double from here to reach Japan-like levels. It will never be paid off. And after a 20% correction in the stock market late last year, the Fed had to completely reverse course, abandon "normalization", begin laying the groundwork for negative interest rates, and talk about QE4EVA.

Seismic activity – after prolonged quiet periods – is what tends to come right before a volcano erupts. Financial markets are not volcanoes.

While the debt builds and the deficits grow, the financial system becomes more complex and more fragile. The real economy weakens. And the instability in a financialized system can mean sudden and violent crashes. That's why we continue to buy gold.
 
Speaking of gold, China bought more last month. Chinese gold reserves grew for the second straight month, according to data published earlier this week by the People's Bank of China. China's back to buying gold after taking some time off in 2016-2018 to try and rein in rampant debt and credit growth.

Why are central banks ramping up gold purchases? And could it be a signal or a catalyst for a bigger move in gold ahead? Hmm...

Central banks buy gold as a reserve asset. And they buy it because it's always been money. That's why they put it in vaults. The second question is tougher.

But I'll repeat that both Bill and I believe before this bull market in gold is over, the Dow-to-gold ratio will be at 3-to-1...likely, with the Dow down at least 10,000 points from here and gold at $5,000 per ounce.

Meanwhile, it's no coincidence that the buildup in central bank gold reserves comes at the same time government debt-to-GDP ratios in the Western world are at their highest levels since the end of World War II.

Wall Street research firm Bernstein says the buildup in gold may be a sign that central banks are preparing for a huge spike in inflation. The firm also says that gold – and not government bonds – will do much better in that kind of market. It reports that:

"A material shift in geopolitical risk and a near-record build up in government debt make other potential risk-free assets more questionable and also bring a temptation to create inflation, thereby further enhancing the case for gold...

"The problem with holding gold is that the long run real return is zero. However, it is also apparent [...] that there are periods when the other traditional source of 'risk free' returns, in the form of Treasury bills, fail to deliver risk-free returns...

"These tend to be in periods of geopolitical uncertainty or after large build-up of debt."

Inflation is the dog that hasn't barked since 2009. That is, if you're looking for consumer price inflation, you won't find it.

But you will find rising health insurance, education, and housing costs. And you'll find soaring financial asset prices, which is where QE has created a huge wealth- effect and also inequality.

But a bigger inflation surge where gold prices soar? That hasn't happened in the QE era...Yet.

Our take: With debt levels building, and common sense suggesting that inflation is the easiest way to manage unpayable debts, inflation is coming.

The geopolitical risk is default, contagion, and conflict between nation-states (armed conflict, not just financial warfare or cyber warfare).

Cheerful? Definitely not. But look on the bright side...

If Modern Monetary Theory takes hold, the destabilization of the whole Ponzi scheme will accelerate. It's like some people actually want the volcano to blow.