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"Interest rates on Treasury securities,
which have been exceptionally low since the recession are projected to
increase in the next few years as the economy strengthens and to end up at
levels that are close to their historical averages (adjusted for
inflation).” – Budget Outlook for 2014, Congressional Budget Office
 
Had the Congressional Budget Office done the math, as
outlined in the table above, it might not have appeared so nonchalant about
the prospect of Treasury paying the historical average interest rate on the
massive federal debt.
The historical average interest rate paid by the Treasury
Department from 1990 - 2013 calculates to 5% and to 7% from 1971 –
2013. The current average interest rate paid by Treasury across the
range of maturities is 2.4%. At 5% Treasury would more than double its
interest payments from $416 billion annually to $867 billion. At 7%,
Treasury interest rate payments would balloon to $1.2 trillion nearly triple
the current interest payment annually.
Tax revenues amount to $2.8 trillion. As a result
interest would take up 31% of revenues at the 5% average rate, and 43% at the
7% average rate. In short, the federal government might be seen by the
rating services in either instance as ultra-high risk, or possibly even
technically bankrupt. As it stands the St. Louis Fed puts the sovereign debt
to GDP ratio for the United States at 103.3%. Anything over a 100% ratio is
considered over-indebted.
Keep in mind that the federal government will have added
nearly $1 trillion (or more) to the national debt when fiscal year 2014 comes
to a close end of September, and no one sincerely believes that the borrowing
is going to come to a standstill, or even that it is going to be cut
significantly.
The federal government in short is ensnared in a debt and
interest rate trap of its own making from which it will be difficult to
extricate itself. Pundits and market analysts alike might believe that
the Fed is going to raise interest rates at some point in the future, but the
reality of higher interest rates might bring far worse consequences than can
be achieved by simply staying the course. Some small, even token, rate
hike is tolerable, but a return to historical norms could reap consequences
in the general economy far beyond the direct effect on the federal
government’s fiscal status.
It is a matter of convenience, perhaps even good politics,
to be discreet about the relationship between the Treasury’s debt, its
associated interest rate burden and the Fed’s ability to raise
rates. Sooner or later, though, the Federal Reserve and the Treasury
Department will be faced with the hidden and unavoidable consequences of
raising interest rates to the historical norms, and the interest rate trap
will becomes apparent to the financial markets, including gold. The Federal
Reserve is already reacting to the problem by deliberately keeping interest
rates down. Blaming that policy on the employment problem, though, might
someday soon become a slight of hand played to an increasingly skeptical
audience.
The
implications for gold
The Everyman edition of Edward Gibbon's History of the Decline and Fall of the Roman Empire
comprises some six volumes and nearly 4000 pages. Rome was not built in
a day and, as Gibbon’s work reveals, it was not lost in a day.
What we are challenged to recognize with respect to U.S. monetary policy
today is not an event, but a process. The decline of the dollar since the
United States went off the gold standard in 1971 has not come in a handful of
sudden, cataclysmic events like formal devaluations, but gradually and
consistently, over a period of four decades coinciding with the steady
decline of the dollar. That
process is likely to continue.
Gold has had long periods where it gained in value during
those four decades, periods when it lost value, and periods when the price
was stagnant. The over-riding trend, though, has been to the upside. In
fact the long-term linkage between the rising U.S. national debt and a rising
gold price is one of the most enduring features of the contemporary fiat
money economy president Richard Nixon launched in 1971. (See chart)
Since the early 2000s, when gold’s most recent bull
market began, periods of stagnation like the one we are in now have reaped
the highest rewards for the patient buyer. The lesson here is one as old as
the gold market itself: The
time to buy is when the market is quiet. As an old friend and
client used to say (he recently passed away) when the market was stuck in the
$300 range: It is not a question of if
but when. He
lived to see his prediction come true and his estate reaped a small fortune
from his gold coin holdings.
The continuing inability of the U.S. federal government to
come to grips with its fiscal problems largely explains the enduring, some
would say stubborn, presence of gold coins and bullion in millions of
investment portfolios around the world – including those of central
banks, hedge funds and sovereign wealth funds. Until such time as fiscal
rectitude takes hold in the halls of Congress -- an unlikely proposition any
time soon – current gold owners are likely to hold tight and new gold
owners are likely to continue joining their ranks. In the end,
contemporary gold owners by and large do not own gold to become wealthy, but
to protect the wealth they already have.
"There's a growing gap between what central banks are
telling us about inflation versus what people are really experiencing in
day-to-day life. There are a lot of reasons for this but I think it's
important to understand that [nation] states are broke, and therefore they
are looking at ways to default on their own citizens. And inflation is one of
those mechanisms. So it's not surprising they don't tell you that's what they
are doing."
- Philippa Malmgren, former White House official, White
House liaison to the Federal Reserve and member of the President's Working
Group on Financial Markets (Plunge Protection Team) in a King World News interview.
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