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An Ominous Setup

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Throughout the past few weeks, I’ve been stunned by the transformation all around me. Whether we look at the economy, the social dynamic, domestic politics or geopolitical realities, the rate of change and the possible outcomes make for a terrifying contemplation.

Let’s look at the economy first. The consumption miracle, debt-driven since the mid-1970s, appears to be near its end. The same could be true of the decades of excessive corporate leverage; bank data show that lending to thousands of zombie companies is in sharp contraction. Of course it’s possible that the world’s central banks, led by the Federal Reserve, will once again engineer massive bailouts, create vast new oceans of liquidity, and by doing so, debase the currency further. If that is the outcome, inflation will explode.

By now, this cycle of recklessness is old hat, which is why most adults perfectly understand what’s going on. They understand that while they undergo steep drops in their standard of living, bailouts and other manifestations of crisis-management are freely accessible to the wealthy—on a scale only imaginable in dreamland. It’s why we’re headed for income and wealth disparity not seen in nearly a century. One stark reality: the disparity model is far more pronounced in the United States than in most developed economies. Imagine, the nation that sees itself as the champion of capitalism and democracy, is the nation where 10% of the population owns 69% of all wealth. Conversely, the bottom 50% can lay claim to 2.5% of total wealth.

Let’s take the latest available OECD and IMF data and push this inquiry a step further. A look at what the truly rich own shows us that Americans now experience a wealth gap far larger than their cousins in Europe, Japan or Canada. To be exact, the U.S. imbalance is now centered somewhere in the universe of the developing world. In fact, China now has a larger middle class than the self-styled leader of the “liberal world order”. Ouch!

Enriching The Rich

As I said earlier, it took people a while to understand this, but now they’re there. The social implications are enormous. As even major banks now routinely report, whether we look at Germany, Britain, France or America, the populace is angry. Here is how Benjamin Picton of Holland’s Rabobank put it in a recent letter: “Discontented citizens in a number of countries are losing patience with monetary frameworks that enrich those closest to the spigot while debasing the coinage of the realm and repeatedly failing in their one main job of preventing economic calamity.”

And how do governments react to their citizens’ displeasure? In almost all cases with more borrowing and intensified overreach. Going back to America’s model, annual interest expenses on the country’s monumental debt now surpass $1 trillion, compared to “defense” costs of $766 billion and an education and social services budget of $677 billion. And while this goes on, to make sure that citizens continue to shoulder the cost, the IRS is hiring a few thousand more tax enforcers, a move that will boost the number of the tax authority’s agents to 94,000.

I can’t speculate about the exact consequences, but the set-up looks ominous. I’m pretty certain that domestic political landscapes will continue to change towards extremist platforms, as polarization deepens further. Chances are high that several Western nations will descend into quasi dictatorships, as the need to quell social pushback rises.

Geopolitics: A New World

Even more precarious than the domestic political environment is the geopolitical transition. Logically, by far the most consequential developments are those in the United States. After all, with governments in much of the EU, Britain, Japan, Canada and Australia all acting like Washington’s vassals, even small changes in U.S. strategy can have huge global impact.

So what’s up in the U.S.? To begin with, the nation is in complete inner turmoil. Nothing could illustrate America’s desperate condition better than its two primary presidential contenders. As a European friend said to me the other day, “Each time Biden or Trump have something to say, they sound like figures from old-style banana republics.” Then he added, “Can’t the American people see that?” I wasn’t sure how to answer that. My personal experience of the past few years is that the elites still believe in American exceptionalism, while what’s left of the middle class is losing faith and the majority of the worker-bee class has long given up. Of course, my interaction with Americans may not be representative of the overall mood.

One relevant question is whether public opinion even matters. Absent a serious social pushback, the corporatist elites and the government operatives they control will continue on their present path, while an obedient media complex will spin the narratives that support it. Moreover, when it comes to the execution of their most important objectives, both political parties are in complete alignment. Invariably, Democrats and Republicans enthusiastically embrace the American exceptionalism notion, just as they agree on the necessity of upholding the “rules based international order” and its corollary, the forever war. Together, these platforms are a necessary part of maintaining an Ameri-centric world.

But, as of late, things aren’t going so well. The BRICs block is expanding and now includes some nations previously aligned with U.S. interests. Meanwhile, China’s influence in Africa, the Middle East, Eurasia and Latin America is growing. Back home, the government is backtracking on the “Ukraine is winning the war” propaganda, while some NATO members have lost their appetite for a continued engagement. Media attention has also turned away from Ukraine and is now fully centered on the next war, the one in Gaza. Interestingly, Washington’s fervent support for Israel’s tactics isn’t playing well with a sizeable part of the Democrats’ traditional support base, just in time for the presidential election. And all along, the administration and numerous legislators are pushing for further escalation with China.

The bottom line: on the geopolitical front, as well as domestically, it looks like the United States—and along with it the collective “West”—are headed for even greater chaos.

Portfolio Comments

“It’s interesting how you always bring everything back to gold,” a reader commented after my last issue. I certainly have done that during the past five years, and it’s paid off. I could restate all of gold’s virtues here, but let’s keep it simple. Until I see evidence that a period of sustained low inflation and a strong U.S. dollar are in the cards, I see no reason why we should abandon our core holding in the yellow metal.

As I’ve commented in previous issues, I’m not aligned with those who predict an imminent  collapse of the U.S. currency. Nominal and real interest rates in the U.S. are still attractive when compared to most other major currencies, and as long as that is the case the displacement of the dollar as a trade settlement and central bank reserve currency will proceed at a gradual pace Still, what counts is that the era of dollar hegemony is ending, and that has positive implications for gold.

I also see little evidence that inflation is receding in a sustainable manner. To begin with, consumer price data as supplied by many governments are grossly misrepresenting price pressures experienced by the consumer. Food, energy and shelter, in particular, have risen at a much faster rate than the indices state. Even worse, in many countries the application of taxes imposes a massive burden on the consumer. In Canada, for example, the application of the carbon tax, as well as provincial and federal sales taxes, can boost a trucker’s diesel bill by more than a third, none of which is included in the inflation calculation.

The explosive global situation provides another reality check for those who believe the current decline in inflation will be permanent. Supply chain problems are unlikely to recede any time soon, not just on the energy front but across the board. Then there is the impact from the wars in Ukraine and Gaza. In regard to the former, the ongoing application of sanctions makes for a degree of price volatility not seen for a long time, while any escalation of the Gaza crisis could quickly send energy prices into uncharted territory.

But even in the absence of such disruptive events, out-of-control money printing will keep the inflationary fires fanned, which will ultimately undermine faith in our currencies and financial systems. Gold is benefitting from this dynamic. Last week, it reached a new all-time high of US$2,070, before giving back a small portion of its gains. We expect further appreciation.  

Stock and bond markets have also had a good month, driven by growing conviction that a “pivot” in interest rates is imminent. My own view: I agree that it’s likely that the Fed and other central banks will pause their rate hikes and may even reverse gear. However, due to my inflation concerns I doubt that interest rates will enter a period of sustained decline. That means the stock and bond market advances may prove short.

All in all, we remain in a period in which caution is imperative and agility will be your friend.

Best wishes for a restful holiday season and for a healthy and joyous 2024!

Peter C. Cavelti

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