U.S. Gov’t Ensnared in a Debt & Interest Rate Trap – Here’s What It Means For Gold

Should the Fed raise interest rates at some point in the future, as is widely expected, such higher interest rates might bring far worse consequences than can be achieved by simply staying the course.  While some small, even token, rate hike would be tolerable, a return to historical norms could reap consequences in the general economy far beyond the direct effect on the federal government’s fiscal status. The fact is that the federal government is ensnared in a debt and interest rate trap of its own making from which it will be difficult to extricate itself. 

The above introductory comments are edited excerpts from an article* by Michael J. Kosares (usagold.com) entitled The interest rate trap . . . and what it means to the gold market.

The following article is presented by Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!),  www.FinancialArticleSummariesToday.com (A site for sore eyes and inquisitive minds) and the FREE Market Intelligence Report newsletter (register here; sample here).  This paragraph must be included in any article re-posting to avoid copyright infringement.

Kosares goes on to say in further edited excerpts:

Let’s put some numbers on the above assertion that the federal government is ensnared in a debt and interest rate trap of its own making from which it will be difficult to extricate itself.

The currently average interest rate paid by Treasury across the range of maturities is only 2.4% [see table below] compared to 5% on average between 1990 and 2013 and 7% during the full period from 1971-to 2013. With current tax revenues amounting to $2.8 trillion a return to a rate at:

• 5% would more than double its interest payments from $416 billion annually to $867 billion and take up 31% of revenues and at
• 7% Treasury interest rate payments would balloon to $1.2 trillion, nearly triple the current interest payment annually, and would take up 43% of revenues.

Keep in mind that the federal government will have added nearly $1 trillion (or more) to the national debt when fiscal year 2014 comes to a close end of September, and no one sincerely believes that the borrowing is going to come to a standstill, or even that it is going to be cut significantly.

It is a matter of convenience, perhaps even good politics, to be discreet about the relationship between the Treasury’s debt, its associated interest rate burden and the Fed’s ability to raise rates.  Sooner or later, though, the Federal Reserve and the Treasury Department will be faced with the hidden and unavoidable consequences of raising interest rates to the historical norms, and the interest rate trap will becomes apparent to the financial markets, including gold. The Federal Reserve is already reacting to the problem by deliberately keeping interest rates down. Blaming that policy on the employment problem, though, might someday soon become a slight of hand played to an increasingly skeptical audience.

The implications for gold

What we are challenged to recognize with respect to U.S. monetary policy today is not an event, but a process. The decline of the dollar since the United States went off the gold standard in 1971 has not come in a handful of sudden, cataclysmic events like formal devaluations, but gradually and consistently, over a period of four decades coinciding with the steady decline of the dollar. That process is likely to continue.

Gold has had long periods where it gained in value during those four decades, periods when it lost value, and periods when the price was stagnant.  The over-riding trend, though, has been to the upside. In fact the long-term linkage between the rising U.S. national debt and a rising gold price is one of the most enduring features of the contemporary fiat money economy president Richard Nixon launched in 1971. (See chart below)

Since the early 2000s, when gold’s most recent bull market began, periods of stagnation like the one we are in now have reaped the highest rewards for the patient buyer. The lesson here is one as old as the gold market itself:  The time to buy is when the market is quiet. As an old friend and client used to say (he recently passed away) when the market was stuck in the $300 range:  It is not a question of if but when. He lived to see his prediction come true and his estate reaped a small fortune from his gold coin holdings.

The continuing inability of the U.S. federal government to come to grips with its fiscal problems largely explains the enduring, some would say stubborn, presence of gold coins and bullion in millions of investment portfolios around the world – including those of central banks, hedge funds and sovereign wealth funds.

Until such time as fiscal rectitude takes hold in the halls of Congress — an unlikely proposition any time soon – current gold owners are likely to hold tight and new gold owners are likely to continue joining their ranks.  In the end, contemporary gold owners by and large do not own gold to become wealthy, but to protect the wealth they already have…

Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.

*http://www.usagold.com/publications/Sept2014R&O.html (If you appreciate the kind of bedrock analysis you just read, you would probably enjoy and gain from our e-mail newsletter service which alerts you whenever a new issue is published. It comes free of charge (subscribe here) and you can opt out of the service at any time. Last, we will not deluge you with emails.)

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