Kicking the can on the road is the new national pastime. Every time it’s time to pay government bills, Treasury officials find creative ways to pay money they don’t have.
One measure of how much expansion in the United States has increased fiscally is the debt-to-GDP ratio. For most of the country’s history, with the exception of periods of temporary war, the general net government debt has tended to be less than 50% of the economy.
In the early 1970s, debt as a percentage of GDP fell to less than 25%. By the early 1980s, it had grown to more than 30% and financial hawks became anxious. In the 1990s, it rose to more than 40% and anxiety began to turn into a state of anxiety.
Last year, the US official debt-to-GDP ratio exceeded 100% (1:1). In other words, taxpayers owe more than the value of everything they produce.
This portends death for most countries. The International Monetary Fund issues severe warnings to third world countries when they cross the 70% threshold of GDP.
The United States is different, it seems, thanks to the status given to the Federal Reserve note as the world’s reserve currency. Until 1971, this status was backed by a promise to return the dollars held by foreign governments in gold.
Gold has also constrained spending and borrowing at the federal level.
But since President Richard Nixon eliminated the possibility of recovering gold, politicians have been given the green light to repay debts without limits.
If White House Joe Biden gets to pay all of his spending proposals, an additional $9 trillion will be added to the national debt. Except for the corresponding miraculous rise in GDP, a continuation of the trend of the debt ratio can be expected in the wrong direction.
How long Washington officials can keep kicking a can on the road before it is kicked off a cliff is unknown. These are, after all, unprecedented times when the Federal Reserve, a “lender of last resort”, has nearly unlimited powers.
But the central bank cannot permanently save Uncle Sam without unintended consequences. Avoiding a debt crisis could mean unleashing a currency crisis.
Gold is on its way to outperform the stock market
During the major financial crises in history, gold vastly outperformed paper assets.
For example, both the Great Depression and inflation of the late 1970s saw the price of gold reach a 1:1 ratio versus the Dow Jones Industrial Average.
The Dow is trading over 35,000 today, about 20 times the price of gold.
Dow Index: Gold Ratio, since 2000.
If the Dow:Gold ratio returns towards 1:1, either the stock will crash, and gold will have to take off in a big rally, or a combination of both.
Given the massive inflationary pressures currently exerted in the economy, the late 1970s may be the best model for what to expect in the future.
It could mean higher price levels combined with a weak economy (stagflation).
Given that our debt burden today is four times greater as a share of the economy than it was in the 1970s, investors should prepare for the possibility of a much larger financial crisis.
In the event of a collapse in the value of the US dollar, it is clear that gold will serve as the main safe-haven asset.
Silver is set to outperform gold
But silver could do better as an inflation hedge. It did so during the late 1970s preceding its January 1980 super high at nearly $50/oz.
Some dismiss the move as being artificially caused by the Hunt brothers, who tried to corner the silver market. They should not discount the possibility of another crazy scramble for scarce supplies of silver, however, fueled by broad and deep global demand rather than a handful of speculators in the futures market.
This time it could be Tesla or a solar panel manufacturer, for example, that is trying to “crawl” the silver market by piling up strategic stocks.
Or it could be a large number of individual investors mobilized in Internet forums to collectively “crawl” the physical silver market. Crowdsourcing campaigns led by silver enthusiasts are already underway to try to force paper futures traders who engage in naked short selling that artificially curb spot prices.
At the moment, silver remains relatively cheap against not only most financial assets, but also other fixed assets. In March 2020, silver became historically cheap against gold – at one point it sent the gold:silver price ratio to a record 130:1.
Gold: Silver Ratio, 1990-present.
The gold:silver ratio is currently at around 76:1. There is still more room to narrow in favor of silver during the bullish precious metals market.
At the height of the 1980’s, the ratio approached 16:1, which is often referred to as the “classical ratio” that has been observed since antiquity.
Meanwhile, the current mining ratio is around 7:1, according to First Majestic Silver CEO Keith Neumeyer. This means that mines around the world produce 7 ounces of silver for every ounce of gold that they put on the market.
With so many ratios that seem to be out of control, it would be wise for investors to reconsider the ratio of fixed assets to paper assets in their portfolios. And those who already have a discreet allotment of gold bullion should make sure that they also have a sufficient percentage of silver holdings.