The answer: Gold.
The question: What is the best investment to own today as the Federal Reserve begins raising interest rates?
How we get to the answer — an answer that would seem to fly in the face of conventional wisdom — is why I come to you today. And this answer will reveal to you why you should own gold.
It’s not the destination; it’s the journey. I’m sure you’ve heard that old saw many times. Well, in this case, that’s all wrong. As Yellen & Co. nears the start of the first rate-hike cycle we’ve seen since the summer of 2004 to the summer of 2006, the Fed’s ultimate destination with interest rates is the only subject that really matters.
Though the stock, bond and currency markets at the moment are preoccupied with the question of when the first interest-rate increase will happen, the real story lies in where interest rates are ultimately headed … because that answer defines where stock, bond and currency prices are ultimately headed.
And the reality, dear Reader, is that the Fed simply cannot — and will not — allow interest rates to crawl very high. They know that with every tick up, higher and higher interest rates will increasingly crimp Washington’s style — that “style,” of course, being D.C.’s penchant for wanting to splurge big on buying votes by spending stupid amounts of money on stupid programs.
See, D.C. has itself in a bit of a bind, as you likely already know. For more than half a century, the goobers we’ve elected to Congress have been spending our tax dollars as though they won’t live to see tomorrow and, so, what the hell: Let’s live for today! Now we have that $17 trillion in public debt that you always read about — and the $120 trillion in unfunded debt on and off America’s balance sheet that you don’t always read about but that is, nevertheless, all too real.
Because of that, rising interest rates pose a significant challenge for the Fed and for Congress.
Consider some numbers and you will quickly understand the problem we face as a first-world nation rapidly moving toward Banana Republic status:
- In 2013, America’s interest payments cost U.S. taxpayers $415.7 billion. Some commentators I’ve read have used that as proof that we’re finally getting our debt under control because in 2007, interest payments were higher, at $430 billion.
- But in 2007, total debt was just $9 trillion vs. $16.7 trillion at the end of 2013.
- Also in 2007, the average annual interest rate across all maturities of Treasury debt was 4.94% vs. just 2.02% in 2013. So in 2013 we had a much larger sum of debt, but benefited from exceedingly low interest rates.
- The Congressional Budget Office calculates that if interest rates move back toward norms by 2020 — meaning 10-year notes at 5% (they’re 2.4% today) and 3-month T-bills at 3.7% (they are 0.03% today) — our annual debt payments will explode to more than $840 billion, double what we’re paying now.
The Long, Long Road to 2%
Think about America today — a country already gasping under the weight of too much debt. And then think about an America where debt-service payments have doubled.
That world implies a vicious debt-cycle, in which the country must issue more debt to make debt payments, which then leads to more debt as the debt payments rise because of all the new debt needed to repay the existing debt. It also means a dramatic change to America’s tax-rate structure. The wealthy class now responsible for 39% of all federal taxes, will be forced to dig even deeper into their wallets. The middle-class now responsible for just 3% of all Federal taxes paid will see their lifestyle shrink as more taxes come out of their paychecks. And the lower-middle-class that now earns money from the federal tax system, will suddenly feel the sting of Uncle Sam’s pick-pocketing ways as their tax benefits become tax obligations.
In short, America’s consumer-dependent economy would face unmanageable headwinds as consumers lose a meaningful portion of their spending power to government taxation.
Worse, the taxes we pay would not turn around and flow back into the economy but would, instead, flow to holders of U.S. debt, many of whom live overseas. We would, in essence, be working our butts off so that a debt-drunk Uncle Sam could send ever-larger sums of our tax dollars to the Chinese, the Japanese, the Russians, the Brits, the Taiwanese and others.
Ultimately, that would be a political, social and financial disaster for Washington, D.C. And the Fed is smart enough to realize these ramifications exist … which brings us back to the main point: the Fed’s ultimate destination with interest rates.
Though rates will soon begin moving up for the first time in nearly a decade, the Fed will — and must — continue strong-arming the market to keep rates unnaturally low. My guess: the Fed-funds rate, the Federal Reserve’s key interest-rate lever, will not go higher than 2% and, more important, getting there will take years, not months. The Fed will not raise rates in rote 0.25% step-ups over a few meetings. It might move in 0.1% increments, and it could go several months or maybe even a year between rate hikes.
In short, we’ve been stuck at near-0% interest rates for more than five years … and it very well could take the Fed another five years or more to get us back toward 2%, simply because it knows that Congress has worked itself into an impossible financial situation.
Thus, the Answer: Gold
The knock on gold is that it pays no rate of return and is, therefore, not a smart asset to own when money in the bank or in Treasury paper offers a decent yield.
But while rates will begin to rise, money in the bank or in Treasury paper will still offer no real yield in the future, given that inflation has begun to move up as wages now rise (a little jab to the gut from all those efforts to push minimum wages higher). That means inflation will equal or outpace the interest rates you’ll be able to earn in savings accounts, CDs and government bonds.
And that is the environment that is brightest for gold.
When you’re losing purchasing power just by letting your money sit in savings, CDs and bonds, gold is a godsend. Its price tends to rise in such an environment.
So, do yourself a favor. Do not look at the coming Fed rate-hike cycle as an opportunity, finally, to move some cash back into CDs and savings account. Look at it for what it really is: An opportunity to grab gold now, at a fair price, knowing that the Fed has no other option but to keep interest rates exceedingly low for a long, long — long — time.
Until next time, stay Sovereign …
Jeff D. Opdyke
Editor, Profit Seeker
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