The past two issues of our Strategic Updates have triggered an unusual number of questions and reactions from subscribers. We welcome such responses, viewing them as evidence that some of my comments are thought-provoking.
Here then, is a sampling of recent questions and my answers.
Will Government Debts Ever Be Repaid?
Question: “I had no concept of just how enormous government debts were. How do you expect these sums can ever be repaid?”
Answer: Monetary history is replete with examples of debt manipulation and debt defaults. The most common methodology is to make debt meaningless by inflating it away. If a lot of a nation’s debt is owned by foreigners, as is the case with the U.S., meaningful currency depreciation can do wonders, too. That is easily accomplished by keeping interest rates at extremely low levels as inflation rises.
A far harsher resolution is an outright debt default. Argentina, for example, has defaulted on its debt nine times since its independence from Spain in 1816. Ecuador has done so ten times and Portugal four times. Defaults can be absolute, meaning that bond owners lose all. I have a gold- backed Chinese bond issued by the Chiang-Kai-Shek government in 1947 hanging on my office wall. The bottom part consists of a large number of interest coupons, unredeemed and unredeemable.
Quite a number of countries have never defaulted. They include include Canada, Denmark, Belgium, Finland, Malaysia, Mauritius, New Zealand, Norway, Singapore, Switzerland and England.
Why isn’t the U.S. part of this illustrious club? Partly because Washington had a couple of fairly irrelevant glitches (the last in 1979) where the government could not make timely payments on three maturing Treasury bills. Far more relevant, however, is the case of government bonds issued before 1930, which offered redemption in currency or gold. In 1933 President Roosevelt and Congress decided that such a promise was “against public policy”, so they ended it. The issue ended up before the Supreme Court, which predictably ruled in favor of the government.
Is the U.S. more likely to resort to pull a soft or a hard default? Both the concept of a soft default (a combination of high inflation, low interest rates and a resulting depreciation of the dollar) or a hard default would, right now, be highly problematic for Washington. The reason: the gradual replacement of the dollar as a reserve currency already undermines America’s dominance of the international order. That doesn’t mean that a debt default is unthinkable, but it suggests that the government will delay a serious crisis as long as possible. Meanwhile, a seriously weakened Japan, Britain and EU will facilitate such a delay. As long as U.S. allies perceive America as relatively stronger and safer, foreign flows into the U.S. bond market will persist.
The Ongoing Banking Crisis
Question: “Your insights regarding the ongoing banking crisis are appreciated, but you don’t mention the ongoing wave of withdrawals from smaller institutions. How worried should we be?”
Answer: Government actions and comments in response to the current crisis have been unmistakable; if a bank as sizeable enough, it will be protected. In the case of the three major U.S. bank failures, the Treasury Department was quick to suspend applicable limits for deposit- insurance coverage. Yet, when questioned by members of Congress whether such all-out rescues could be expected for smaller banks, there were no such assurances. It didn’t take long for larger depositors to react; many pulled balances above the $250,000 insurance coverage.
In Switzerland, where one of the world’s largest banks failed, the government resorted to even more dubious tactics. It squarely placed Credit Suisse shareholders ahead of the owners of some classes of debt obligations—a move that defied all financial principles.
What all bank customers should know is this. In the wake of the 2008 crash, the supra-national Bank of International Settlements identified the world’s “systemically important banks”, a move that was broadly welcomed by national financial authorities and central banks. It’s implicit that no country will let one of the named banks fail. In the U.S., the list includes JP Morgan, Citigroup, Bank of America, Goldman Sachs, Morgan Stanley, Wells Fargo, BNY Mellon and State Street. The Canadian banks listed are RBC, TD, Bank of Montreal and Scotiabank.
Recommendation: At this time of fairly attractive rates on American CDs and Canadian GIC’s (in each case over 5% on a one-year term) it’s important not to exceed the deposit insurance limit, which is $250,000 in the United States and C$100,000 in Canada. Many brokerage platforms allow you to buy other banks’ CDs or GICs, so that it’s easy to diversify among different issuers.
Our Exposure To The Stock Market
Question: “You talk about what stocks to own, but don’t mention what exposure you currently have to the equity market.”
Answer: Thanks for pointing that out. Given that we still expect the global economy to weaken, and considering that several market sectors are significantly overvalued, we haven’t made significant changes to our top-down allocation. At present, 40% of our model portfolio is in stocks, 10% in bonds and 15% in gold (most of which is in our storage program, in physical, segregated form). The remaining 35% is held in cash-like instruments, yielding an average of 4.05%. As I’ve said many times, our position reflects the vast array of possible outcomes to the current situation. Much of the world has pursued unsustainable policies on virtually every front, for at least half a century. Societal trends are untenable; both the West’s growing wealth and income disparity and the gradual disappearance of the social contract are ominous. Add to that the continuous escalation of tensions with China and other geopolitical conflicts and you have the formula for years of chaos. Your investment portfolio should reflect that.
Central Bank Digital Currencies And Gold
Question: “You mention that the adoption of Central Bank Digital Currencies could benefit gold immensely. Do you really foresee a barter economy based on gold?”
Answer: No I don’t, unless there is a complete systemic collapse, in which case barter transactions might become commonplace. Why do I see gold as a beneficiary of CBDC implementation? For three key reasons.
First, the new environment would allow authorities to scrutinize and potentially manipulate everything, which would make an asset that is universally recognized as a store of value and can be exchanged between individuals with complete privacy, more desirable. Imagine, real estate, stock, bond and now cash transactions would all be digitally monitored.
Second, the history of central banks is deplorable. Oceans of negotiable liquidity (i.e. money) have been irresponsibly printed by the world’s central banks. A digital regime would further facilitate this practice, which would in turn boost the value of assets that are proven inflation hedges and not just someone else’s liability.
The third reason is the possibility of a comprehensive grid failure or even a cyber war. Consider that in such an event on-line access to execute trades or transactions in any financial asset, including cash or crypto-currencies, would be immobilized. It’s hard to imagine such a scenario, but in the context of rapidly building tensions between the U.S.-led West and powers that are advanced on the cyber front it’s nevertheless a possibility. I strongly believe that gold, in physical form, would benefit.
In short, there are good reasons why the CBDC dynamic could become yet another driver for gold.
With best regards,
Peter Cavelti