There’s an old wives’ tale that says if you put a frog in a pot of cold water and slowly increase the temperature to boiling, the frog will die in the water before it realizes that its environment has suddenly gotten very, very dangerous.
The unfortunate parallel for investors in today’s economy is that we are the frogs and the central banks and misguided fiscal policies of western governments are the chefs, slowly turning up the temperature on an inflationary stew that, sooner or later, will become lethal to our financial well-being.
You’d be forgiven for not noticing, what with all the economic turmoil we’ve experienced. But well before the Great Recession of 2008 began, the U.S. Federal Reserve had been applying ever larger doses of loose money as the solution for any and all problems. The record shows that with every successive economic slowdown, the Fed dropped rates lower than the previous occasion and employed even looser monetary policies.
In short, the patient needed ever-greater doses of “medicine”…to the point that the 2008 crisis saw rates locked in at zero and the Fed employing the unprecedented tool of quantitative easing.
It’s been said that, if all you have is a hammer, everything begins to look like a nail. And that’s what the Federal Reserve has been doing over the last two decades — trying to fix a broken economy with ever larger hammers.
The problem with this strategy is two-fold.
First, it makes the Fed beholden to Wall Street. Through all of its easy-money efforts, the central bank specifically aimed to pump up the U.S. equity and real estate markets, thereby creating a “wealth effect” that would have U.S. consumers feeling richer and spending more.
But now they’re a prisoner of the creature they created. The U.S. equity market is essentially the same as the economy, and stock-market weakness will lead to a major economic slowdown.
So Wall Street occasionally pitches a fit — signaling to the Fed when it wants another rate cut — and the Fed is forced to comply. The bottom line is that we’ve transitioned from easy money to ever-easier money, and the central bank dare not disobey the market’s orders.
Second, these unprecedented monetary policies, with 5,000-year lows in interest rates and massive injections of monetary adrenaline, encourage ever-greater levels of debt.
In the U.S., the federal debt has now grown so large that any significant increase in interest rates from current levels would lead to unmanageable debt-service costs. In fact, our research indicates that if the fed funds rate were to reach just 3%, annual debt service costs would near $1 trillion!
At that point and in this political environment, we would undoubtedly hear calls for a default on the debt…an event that would send the value of the dollar crashing.
The bottom line is that the Fed cannot allow interest rates to rise. Essentially, the interest rate on the federal debt must be lower than the rate of dollar depreciation (inflation) to prevent the budget from blowing up.
Translation: We will have negative real interest rates (interest rates minus the rate of inflation) for as long as the current monetary regime is in effect. And that will be tremendously bullish for gold, silver and mining stocks.
The currency of last resort
As the West’s governments and central banks have used cheap money and truckloads of debt to prop up an ailing global economy, their fiat currencies have weakened when measured against gold.
As noted above, that trend will continue…must continue…for years to come.
And it’s not surprising why. Gold boasts a four-millennia-old track record as the only protection against the inevitable corruption of currencies. And thus, there has developed an inverse relationship between fiat currencies and the price of gold.
Simply put, the more dollars, euros, yen and other such currencies that are created, the gre