It has been almost two weeks since Donald Trump has been voted into the White House and the mass media is finally getting their heads around his victory. Most analysts (well, actually all of them) predicted a victory for Trump would be excellent for the precious metals prices, but even though the gold price increased to almost $1350 when the votes were being counted, we closed last week approximately $150/oz lower and the gold price was barely able to hold the $1200 level.
Were we wrong? Was everyone wrong? Why did this happen?
Let’s do some fact-checking here to see why the long-thesis for gold remains in play, more than ever before.
Fact one: Trump has been acting against the Federal Reserve for several months now, claiming the Fed is deliberately keeping the interest rates low to help the current democratic president to leave office on a high. That’s not a ridiculous claim, although the economic recovery might be more fragile than you’d think.
Yes, there has been job growth, but it was predominantly situated in the part-time job categories with low average wages. So, yes, at surface it does look like the economy is doing better, but most of the new jobs barely cover the cost of living, so it wouldn’t be fair to expect a (sustainable) increase in spendable income.
Fact two: The new president wants to jump-start the economy by investing massive amounts in infrastructure-related projects. That’s usually not a bad idea as A) it’s the best way for a government to ‘intervene’ in a domestic economy without becoming too ‘pushy’ or calling the shots and B) it serves a long-term purpose and could actually have a serious indirect impact on the local economy as well.
But this very likely means the Trump administration will continue the Obama-course and continue to run a budget deficit for the next few years. Theoretically that’s not always negative as the cumulatively added value of getting people back at work and improve the existing facilities might pay off over time, but it will increase the pressure on the budget and the total debt situation.
And that’s what might cause some issues here. Right now, the total national debt is zeroing in on the 20 trillion dollar mark, and it’s not unlikely the Trump Administration will have to run an annual deficit of $1T (although it will very likely be more), and this could easily push the total debt to $25T by the end of Trump’s term. Fine, if the GDP is increasing at a similar pace, the debt/GDP ratio won’t change at all, but if you’re running a budget deficit, have a substantial amount of sovereign debt ànd are calling for higher interest rates, it doesn’t take a genius to realize that could potentially be a deathly cocktail.
Let’s use the $20T of government debt as our starting point. Should the interest rates increase to 3.5% (compared to 1.5% on the 10 year T-Note before this summer, and 2.335% right now), the total cost of debt would increase by approximately $400B per year. This sure sounds ‘acceptable’ when compared to the total debt, but let’s see what the trickle-down effect could be.
In the USA, the total labor force consists of 152 million ‘employees’. As it’s tough to tax unemployed people (although governments will always find a way to do so), the entire $400B would technically have to be financed by a higher contribution from the labor force. In this case, every employee in the USA would have to contribute an additional $2,600 per year to fund the additional interest (and not a single dollar of that would be spent on actually reducing the principal amount of that debt).
That’s tough, but the USA isn’t an isolated case.
Countries have become used to and addicted to low interest rates, and it will be very tough, if not impossible, to break through this pattern. Italy might very well be one of the next domino’s to fall if/when the interest rates increase.
The Italian government debt is 2.2 trillion Euro, and a 1.5% increase of the average interest rates would create an annual shortfall of 33B EUR. That’s indeed a fraction of the exposure of the US, but as just 23 million people are employed in Italy, the additional pressure would technically be 1,400 EUR/year (and this is quite a conservative scenario because once the PIGS-issues come back to surface, Italy’s interest rate will very likely increase much faster than for instance Germany’s interest rates).
1,400 EUR/yr is just 120 EUR/month, but try to tell that to people who are making just 1250-1500/month and barely make ends meet.
And this is, and always has been, the real reason to have exposure to gold. Government spending will lead to higher inflation (expectations), and will ultimately renew the interest in gold as a hedge against inflation. And the status of gold as a safe haven will once again be confirmed when higher inflation rates and higher interest rates will push some countries over the edge.
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