I’ve long been an avid and enthusiastic reader of the “In Gold We Trust” report (“IGWT”), as I believe countless other gold investors are, and I’ve always found great value in the insights, the analyses and all the astute commentary and elucidating charts it contains.
However, I was particularly looking forward to this year’s IGWT report. So much had changed, so many shifts and shocks had taken place in 2020, that any conservative and rational investor would surely benefit from Incrementum’s insights. As I expected, it turned out to be an incredibly interesting read.
Given the extreme disruptions, the extent of the damage and the unprecedented interventions in the global economy, it might seem shocking to many reasonable investors and ordinary citizens that political leaders and the mainstream media are already celebrating the “great recovery”, with central planners of all kinds taking credit for it too. It might also seem bizarre, to say the least, that stock markets still keep climbing, dismissing any and all distress signs coming from the real economy.
Among other important topics, the IGWT report addresses these seemingly paradoxical phenomena, while it explains not just their roots, but also what we can expect to see next. It also captures the bigger picture, the longer-term trend that has been developing even before the covid virus ever emerged: the idea of a Monetary Climate Change. This is why I turned to Ronald Stöferle, a long-time friend whose unique point of view and independent thinking I’ve always found very illuminating.
Ronald-Peter Stöferle, is the Managing Partner of Incrementum AG in the Principality of Liechtenstein and the co-author of the widely popular “In Gold We Trust” report.
Claudio Grass (CG): Since the close of the horrible year that was 2020, we have seen a lot of hope and optimism expressed for 2021. This optimism has been strongly reflected in political speeches, mainstream economic analyses and stock markets. However, as you highlighted in your latest IGWT report, there are numerous serious risks ahead, including inflation, extreme and unprecedented debt levels, monetary and fiscal abuses. How do you explain this “cognitive dissonance”? Why are so many investors and “experts” ignoring those risks?
Ronald Stöferle (RS): First of all, it is important to mention that apart from short-term fiscal and monetary reactions to the unprecedented economic downturn last spring, a profound change has been taking place before our eyes: a monetary climate change. This monetary climate change has far-reaching implications— for monetary policy, fiscal policy and investment decisions.
After 40 years of disinflation, falling interest rates and yields, as well as rising stock prices, an increasing proportion of policymakers and investors no longer have a direct experience of an inflationary environment. In this respect, what we are witnessing is not so much cognitive dissonance, but rather lack of experience.
The generational shift that is already taking place is bringing a generation into political, economic and social leadership that has never in its lifetime had the negative experience of severe inflation. It replaces a number of generations that experienced periods of high inflation, if not hyperinflation, firsthand during their lifetimes.
CG: Over the last few weeks, as concerns have grown due to an uptick in official data in the US and elsewhere, inflation has finally entered the mainstream discussion. Central bankers and politicians have rushed to reassure the public, promising that what we are experiencing is just a temporary “glitch”, and that inflation really is under control. What is your take on these assurances?
RS: We could not disagree more: The current inflation developments are a structural phenomenon: a monetary climate change, and not just a temporary inflation front. While deflationary factors have been dominant in recent decades, they are increasingly weakening and being overshadowed by inflationary dynamics in the short, medium and long term.
To name a few of these factors:
- The extreme monetary growth of 2020 is likely to weaken in the current year, if only because of the base effect, but it will nevertheless remain high. An end to the ultra-loose monetary policy of recent years is not in sight, let alone a tightening of monetary policy. Jerome Powell, for example, does not expect interest rates to rise before 2023.
- Leading central banks have implicitly come out in favor of capping bond yields. Australia has already introduced a cap, while the ECB explicitly ensures that the yields of member states’ government bonds are not too far apart.
- The Federal Reserve has already shifted its inflation target upward by switching to average inflation targeting (AIT). Other central banks are considering similar adjustments.
- The debt situation, especially at the sovereign level has deteriorated markedly. Significant interest rate hikes or even scaling back the multi-billion-US-dollar bond-buying programs are virtually impossible.
- In the long term, the massive demographic change facing Europe in particular, but above all China, will have an inflationary effect.
This does not mean, of course, that inflation rates will steadily increase, but inflation will settle at a higher level.
CG: Given the massive printing and spending operations we’ve witnessed since the start of the Covid crisis, and given that they’re still ongoing, do you think there’s any way we can course correct at this point to avoid an inflationary scenario and all the economic pain that it will bring? Or is the damage already irreversible?
RS: Indeed, in 2020 we witnessed the biggest debt increase the world has ever seen in peacetime, yet – and this is important – debt levels were already very high before the pandemic. The fact that a drop can cause a barrel to overflow cannot be blamed on the drop, even if it falls completely unexpectedly from the sky, as it were, in the form of a worldwide pandemic. The barrel can only overflow if it is already too full.
Particularly worrisome is the situation in the US. Federal public debt has reached a level last seen at the end of World War II. And we live not only in times of peace now, but also in times of historically low interest rates. According to recent calculations by the Congressional Budget Office (CBO), interest payments as a share of GDP will reach 8.6% in the US in 2051 in CBO’s rather conservative baseline scenario. This would mean that just under one-third of tax revenues would have to be spent solely on debt servicing. There is no way that these interest payments can be financed out of tax receipts, not to speak of debt repayment.
The only solution, apart from outright default, is an intensification of financial repression, i.e. pushing real yields further into negative territory, aka yield curve control. An illustrative historic example is the US in the 1940s. To finance the war, the Federal Reserve kept the bond yield on US Treasuries consistently low. In April 1942, the Federal Reserve complied with a request to this effect from the Treasury Department. The yield on short-term US bills was capped at 0.375%, while the yield on long-term government bonds was implicitly capped at 2.5%.
The resulting massive expansion of the money supply was bound to have an impact on the inflation rate sooner or later. Inflation did not really break out until after the end of the war. But then, as is so often the case in history, inflation shot up within a few months. In the third month of this inflation cycle, the inflation rate reached double digits. In March 1947, i.e. within less than a year, it surged to 20.1%, pushing real yields into extremely negative territory. As a consequence, public debt decreased sharply within just a few years from 110.7% in 1945 to 62.5% in 1951. Bondholders and savers paid the bill. And things will not be different this time.
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