Will The National Debt Send Gold Soaring?

| About: SPDR Gold (GLD)
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The U.S. national debt is approaching $20tn.

This isn't quite as problematic as many seem to think.

How could this affect gold?

The US debt clock is a pretty scary thing to watch. I took a screen grab as it approaches $20tn.

That surely can't be a good thing. Actually I saw the same debt clock used in Doug Eberhardt's latest article. We must have taken our screen grabs on the same day, but as you'll see, we don't view the figure in quite the same way.

Here's another scary chart:

So is it time to dig a bunker and stock up on gold (NYSEARCA:GLD) and canned food? That may seem an extreme idea, but I've seen it expressed on many forums.

The fall of fiat currency is a hot topic. Google search immediately suggests, 'fiat currency collapse' as the top suggestion when you type in 'fiat currency'. Clearly this is a subject weighing heavy on people's minds.

From a less extreme perspective, the thesis of many gold bugs still revolves around the two charts above. The U.S (and the world) has too much debt and this will eventually lead to problems which will send gold higher.

This is what Doug Eberhardt had to say in his article,

Trump understands that today's borrowing is at a low rate, but he doesn't quite comprehend that adding more debt to the existing debt will result in a higher interest payment on a larger pile of debt when rates go up. When interest rates finally do begin to rise, the real problems will come to fruition in that stocks and bonds both won't like the fact we can't pay all our bills.

At some point, this debt will become a problem.

Not paying our bills is a problem with a capital 'P'.

Has the imminent collapse of fiat currency been hidden from the populace? Let's be honest, if our Dollars were to become useless, the powers that be wouldn't want too many of us knowing.

How Much Debt Is Too Much?

The chart showing the increasing debt must be taken in context. The same trajectory is present in the Dow Jones (NYSEARCA:DIA):

And in U.S. GDP:

So clearly the economy and assets are growing too. But are they growing enough? When we view the debt as a ratio, it reveals more:

U.S. debt / GDP has crossed 100%, a figure last seen in the 1940s during World War II. You can also see the rapid growth of debt / GDP since the last recession in 2009. This looks cause for concern. Is it?

Well according to this article in The Economist, there are levels where default becomes a major risk, but the U.S. is nowhere near them, yet:

Greece and Japan are in the 'grave' risk level, but the U.S. is comfortably in the 'safe' area. However, this does put a degree of faith in what analysts tell you is 'safe'. Analysts get things wrong all the time.

Thankfully we can check certain things for ourselves. The major concern with any debt is default due to missed interest payments. If the interest cost of the debt is too high in relation to GDP then there will be difficulties paying it.

This chart shows there is little danger at the moment. Declining interest rates since the early 1980s have reduced the interest as percentage of GDP back to levels last seen in the 1960s and 70s.

Here is what usgovernmentspending.com has to say on the subject,

The real risk from government debt is the burden of interest payments. Experts say that when interest payments reach about 12% of GDP then a government will likely default on its debt.

So at current levels of <1.5% there is no risk of default.

But what if interest rates rise?

Later we are told,

Interest payments are expected to increase sharply in the near future as interest rates return to normal. Federal net interest costs in 2015 were at 1.24 percent GDP. This is expected to increase to 2.4 percent GDP by 2020.

So even if rates were to return to 'normal' (as they seem to be doing), the increased interest will not be catastrophic. Again we rely on what the 'experts' say about 12% being dangerous, but I think we can agree Federal net interest costs are not about to cause a default when they are between 1 and 3% of GDP.

Good For Gold?

But what if debt keeps growing? Trump's plans will add to the debt just when rates are rising. That may sound bad, but on the other hand, GDP should increase substantially. Therefore not much would change in the charts above. If he were to do exactly the opposite; impose austerity and raise taxes, GDP would likely fall, and again, the charts above would change very little.

This situation does show that the debt isn't likely to be reduced or change course any time soon. Options are limited. The only realistic way to do turn the tide would be to inflate away the debt with negative real rates. This is a scenario where gold would likely surge.

Just how negative rates would have to get is discussed in this Economist article,

For Option 1, he suggests a real rate that starts at zero and falls by 1 point a year (-1%, -2% etc). This would reduce the debt-to-GDP ratio from 100% to 60% within 12-13 years but at the cost of very negative real rates (-12%) by the end, which look implausible. For Option 2, a steady negative real rate of -5% would take 25-30 years to cut the ratio from 100% to 60%, but at -4%, it would take 100 years. For Option 3, a one-off inflation shock would have to be 40% plus in a single year to get the needed effect, which would have other consequences.

25-30 years of a real rate of -5% would be very, very good for gold.


I don't want to tackle too much in this article. I am not an economist; I am a trader and an investor. I wanted to check for myself if U.S. debt was a reason to rush out and buy gold. Actually I think it is, but not because the U.S. is in danger of default, or because fiat currency is in danger of collapsing, but because of the likelihood of a negative real rate.

Disclosure: I am/we are long GLD.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I trade futures. I recently closed most of my swing position above $1200 and I have a small position I plan to add to closer to $1160