Financial D-Day and the Rise of the Gold Vigilantes

In retrospect, we often understand the full impact of events that we might overlook in the moment. Amidst a year crowded with immediate crises—such as the conflict in Eastern Europe, tensions in the Middle East, and the buzz of U.S. elections—there’s a critical issue rising to the forefront: the U.S.’s deteriorating financial state.

Though the average interest rate the U.S. is paying on its debt seems modest at 3.27%, especially when compared to current Treasury and mortgage rates, it’s the highest we’ve seen since 2008. Back then, the U.S. debt was slightly above $10 trillion; fast forward to today, and it has ballooned to over $34 trillion. Notably, while it took over a century to reach the first $10 trillion, the most recent $10 trillion was amassed in just four years.

Despite political shifts in the White House, the upward march of debt has continued unabated. This was of less concern when interest rates were low. However, in the wake of 2022’s significant inflation and the Federal Reserve’s aggressive response, the true weight of the national debt has come into sharp focus.

The consequences of these higher rates are stark, with annual interest payments on the debt now topping $1 trillion—overtaking defense spending and on par with Medicare. This trend suggests that interest payments could soon surpass even Social Security as the largest budget expenditure.

us debt interest cost
Source: Bloomberg, Financial Sense Wealth Management

The U.S. is on the brink of a financial challenge with nearly $9 trillion of its debt approaching maturity within the next year. This debt will need to be refinanced at interest rates much higher than when it was originally taken on—almost twice as high, in fact.

us due next 12 months
Source: Bloomberg, Financial Sense Wealth Management

To manage the situation and keep costs down, the U.S. Treasury has been leaning heavily on issuing Treasury bills, or T-bills, rather than opting for bonds that pay interest over time. T-bills work like IOUs where, for example, you buy one for $95 and the government pays you back $100 at maturity. On the other hand, with bonds, you’d get your $100 back plus regular interest payments. In the first quarter alone, T-bills accounted for 87% of all debt issued by the Treasury—the most since 2008, excluding the COVID-19 downturn. If the same proportion were in interest-bearing bonds, we'd see our annual interest costs skyrocket to over $1.5 trillion. Washington, we have a problem.

Financial D-Day: March 1st 2024

Just like the Allied invasion of Normandy on June 6th, 1944 became a historic pivot during World War II, March 1st, 2024, could become a day to remember for the U.S. economy. On this day, we observed a significant upswing in gold prices, soaring from $2,039 to over $2,300 per ounce—a breakthrough after being stuck below $2,000 for years.

This surge in gold prices came as no surprise to those watching the signs, much like military movements foretell a looming assault. One major catalyst for the increase in prices has been a buying spree by central banks around the globe, with unprecedented back-to-back annual purchases exceeding 1,000 tons in 2022 and 2023, as reported by the World Gold Council.

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The surprising aspect for many market observers is the resilience of gold prices, even as traditionally dampening factors like a robust U.S. dollar and climbing interest rates come into play. Typically, as interest rates rise, gold prices tend to drop. But since March 1st, they’ve defied expectations by climbing in tandem. While several theories circulate in financial circles, we see this trend as a reflection of the U.S. government's weakening financial position. Investors seem to be turning to gold as a safeguard against fiscal instability, bracing for economic outcomes that could strain government finances, whether or not a recession hits.

Economically, we’re at a crossroads: if the economy avoids recession and heats up, higher interest rates could make servicing national debt more expensive, potentially outpacing even Social Security spending. If a recession does hit and interest rates fall, decreased tax revenue could cause the deficit to surge. Either scenario suggests an increase in the national debt relative to the U.S. economy, a ratio that gold prices seem to shadow. Historically, we've seen gold prices respond to shifts in the U.S. debt-to-GDP ratio, and recent trends suggest investors expect this ratio—and gold prices—to climb even higher.

us debt gdp gold
Source: Bloomberg, Financial Sense Wealth Management

Currently, the U.S. government is spending at levels typically only seen in a recession or financial panic, even though we're not in either. In just one year, the Treasury has ramped up its debt issuance from under $1 trillion to more than $2.5 trillion—an amount that surpasses what was spent during the 2008 financial crisis, the worst downturn since the Great Depression, and is second only to the spending during the Covid-19 pandemic.

us treasury debt issuance
Source: Bloomberg, Financial Sense Wealth Management

Fiscal Dominance Likely to Force the Fed’s Hand

The Federal Reserve has reduced its balance sheet from a high of $8.9 trillion in 2022 to $7.4 trillion, partly due to interventions following bank failures last March. Despite these reductions, the flood of new U.S. Treasury debt—combined with persistent inflation that's resisting the Fed's 2% target—is likely to compel the Federal Reserve to act again.

This tension arises from a situation known as 'fiscal dominance,' where the government's budgetary decisions overshadow the Federal Reserve's monetary policy. This can limit the Fed's effectiveness in managing inflation. Despite efforts to cool the economy by raising interest rates and cutting back its balance sheet, the government's increased spending is contributing to high demand for cash, keeping interest rates from falling.

government spending powell bus

The current situation has led to a surplus of U.S. debt, pushing interest rates higher as the amount issued outpaces demand. There's a growing risk that the Federal Reserve may have to step back into the market to buy up debt, essentially printing more money, an action that could have significant implications for the economy.

Cumulative effect of the deficit could force the Fed to buy debt, says Columbia's Charles Calomiris (CNBC)

The possibility that the cumulative effect of deficits will cause money printing to result from the unwillingness of people to continue to bear increasing amounts of government debt, which forces the Fed to step in and purchase the debt that is effectively printing money…

If we don't do something about the cumulative deficits that are being forecasted based on our entitlement programs, we will hit that point and that will lead to some sort of convulsion in the bond market followed by a very big increase in inflation.

Over the past six months, Federal Reserve Chairman Powell has emphasized the commitment to reducing inflation to the 2% target, making it clear that they will persist until that goal is reached. Despite this, in the December 2023 meeting, Powell resisted suggestions to increase the inflation target above 2%. Yet, in a recent meeting on March 20th, the Fed unexpectedly raised its economic growth predictions for 2024 and slightly increased its inflation expectations, all while maintaining plans to cut interest rates three times. This raised eyebrows—why anticipate stronger economic growth and higher inflation but still plan to ease interest rates?

The answer may lie in a nuance that went largely unnoticed at the press conference. Chairman Powell repeatedly indicated that the 2% inflation target would be met gradually, "over time." This suggests that the Fed may be willing to lower interest rates before hitting the 2% mark, betting on long-term trends rather than immediate targets. This subtle shift implies that the Fed might be preparing to accept a higher inflation range of 2-3% or even 3-4% in the future if the anticipated gradual reduction doesn’t materialize as quickly as hoped.

The Gold Vigilantes & Preparing the Portfolios for Financial War

Back in the 1980s, economist Ed Yardeni introduced the term "bond vigilantes" to describe investors who push for higher interest rates on government debt as a way to protest inflation-inducing policies. These investors effectively influence government actions by selling off bonds, which increases yields and, in turn, the government's borrowing costs. This acts as a safeguard against what they see as reckless spending.

Today, we might be seeing the emergence of "gold vigilantes," investors driving up gold prices to signal concern over fiscal policies in Washington. In anticipation of potential fiscal instability, we've strategically positioned our client portfolios, maintaining strong investments in precious metals and diversifying into other assets like energy and cryptocurrency ETFs. Our goal is to protect against currency devaluation and capitalize on rising commodity prices.

To hedge against interest rate hikes, our bond investments are chosen for shorter maturities, currently yielding around 5% on cash due to increased short-term rates. Additionally, we've secured our positions against market volatility by liquidating some tech stocks, reducing our equity exposure to a more conservative level.

We're prepared for market adjustments and have a list of promising sectors for future investments, including nuclear energy, cybersecurity, AI, aerospace and defense, and undervalued consumer stocks. If you have any questions about our investment strategy or your personal portfolio, feel free to give us a call at (888) 486-3939.

For related podcast discussion of today's article on Financial Sense Newshour, see Smart Macro: Rise of the Gold Vigilantes for audio.

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Advisory services offered through Financial Sense® Advisors, Inc., a registered investment adviser. Securities offered through Financial Sense® Securities, Inc., Member FINRA/SIPC. DBA Financial Sense® Wealth Management. Investing involves risk, including the loss of principle. Past performance is not indicative of future results. This material has been provided for informational purposes only.

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Chief Investment Officer
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