Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Gold Prices And Debt Levels - Trillions And Quadrillions Of Reasons To Finally Make The Connection

|Includes: GLD, iShares Gold Trust ETF (IAU)

Caveat: Have your blue and red pill ready when reading this article.

(I assume members of the Ninja generation are familiar with the first "Matrix" movie, so here we go without further pill color explanations):

Japan's debt just passed a quadrillion JPY. That's a lot of zeros:

Japan's soaring national debt, already more than twice the size of its economy, has reached a new milestone, surpassing one quadrillion yen.

Let the word quadrillion roll around in your brain for a moment or two, because it is not something you hear every day. Quadrillion. 1,000,000,000,000,000. Really.

A paltry million is the numeral one followed by six zeros. A billion? Nine zeros. A trillion is getting up there: 12 zeros. But the mighty quadrillion has 15 of them.


I assume most readers on SeekingAlpha don't live in Japan and don't hold significant amounts of assets in JPY, so why should they care?

I will soon answer this. (Think of Japan as the next Lehman Brothers).

But let's first look at the public debt situation closer to home for most readers; officially the US debt is at "just" (slightly ironic) 17 trillion USD - but when including future expenditures the results are even worse:

The US debt burden is much greater says Boston University economics professor Laurence J. Kotlikoff, who served on President Ronald Reagan's Council of Economic Advisers.

"If you add up all the promises that have been made for spending obligations, including defense expenditures, and you subtract all the taxes that we expect to collect, the difference is $211 trillion. That's the fiscal gap," Kotlikoff said in an interview with National Public Radio. "That's our true indebtedness."

According to the US National Debt Clock, the US government has a $16.8 trillion debt, which comes out to be over $53,000 for each US citizen. Looking at those steadily accumulating numbers, it is difficult to see how the US will square the circle of a steadily-aging population together with the harsh reality of the modern economy.


The debt problem also includes the second-largest economy (China), which finds itself in the same bad situation, only that its problems are more closely linked to its shadow banking system and private debt:

Over the last thirty some odd years, the world has seen an unprecedented level of economic growth and prosperity. That much is certain. However, things are not as they appear when the bullish rose-tinted glasses that most view the world through are removed.

And the issue is debt.

It isn't just the U.S. housing market. It's the world. China's people are currently being sated by an endless funnel of credit and liquidity. Well, not endless. As a bubble gets larger and larger, the amount of debt eventually becomes too much to bear. China is no exception, as is the world.


Given these facts, I have a few simple questions for readers - before finally making the connection to the shiny metal mentioned in the title:

1. Will most politicians continue to overspend "thanks" to the current fiat money system? Do central banks and these politicians all over the world have lots (more precisely trillions and quadrillions) of incentives to keep interest rates (artificially) as low as possible? My answers are probably easy to guess: Yes and Yes. The ZeroHedge article quoted above states:

Right now, for some unbelievably stupid f%cking reason, everyone thinks its okay that practically every developed country in the world is purchasing its own debt. QE in the simplest terms is government-sponsored financial leverage. I am astounded that, at the very least, nobody realizes what a terrible precedent this sets. If ya can't pay the debt, why not buy it and inflate the financial system/rich people! Sovereign debt repos by sovereigns to infinity! Great idea!

Sorry for the expletives, but maybe they are needed to wake many people up. On to question two:

2. What will happen to debt servicing and interest payments (as % of government expenditures) in the US, Europe and Japan once interest rises again to historic long-term medians or above? Or will this never happen "thanks" to the magic hands of central banks and the BIS?

Let's turn to a possible starting point for this ZIRP (zero interest-rate-policy) structure to collapse: Study Japan's current debt to GDP, its tax income potential, its demographic structure and its domestic mega-banks already holding most of the government bonds (JGBs)*.

Again, if you think that Japan is far, far away - that's probably the same as saying failures of Bear Sterns, AIG and Lehman Brothers would be isolated problems not relevant to the rest of financial system before the autumn of 2008. We all know how that turned out.

I can't go into further details, I will just give two hints for a worldwide domino effect:

  • As we all know, China and Japan are the two largest holders of US Treasuries.
  • At the very least you can expect investors to re-price government bond risks immediately - resulting in rising interest rates.

3. What will likely happen to gold prices in case of major economies defaulting or near defaults? Paul Krugman might answer this question is irrelevant since it will never happen, the FED can print as many USD and the Bank of Japan as many JPY as needed in case of emergencies (by the way, this probably means we lived in a never-ending emergency for over five years now in many industrialized countries, but that's another point...). But in my view, the outcome of printing will be the same as a default in real terms: The bond investor is paid back nominally in full - but the fiat money will have lost most of its purchasing power.

(This is another problem for Greece and other countries "trapped" in the Eurozone, they can't even turn on a printing press on their own - so much for the theory of an "optimum currency area". Expect to hear about more the EUR crisis once the German elections are over in autumn of 2013. These problems are not solved and will most likely require another haircut in the Eurozone...)

There we finally had it, hidden in question three: The connection between rising (public) debt levels and rising gold prices.

As long as gold can't be printed, gold remains a safe haven whenever a fiat currency crisis hits - this was true for thousands of years. Don't think that the current fiat money systems coupled with FRB (Fractional Reserve Banking **) will not run into this debt problem sooner or later. Historically, fiat money systems never survived more than a couple of decades - thanks to the magic of FRB, compound interest and money forced into chasing worse and worse credit seekers over time.

I still owe you my answer to the third question and you can guess the answer by now: I think gold prices will rise over time - against the USD, JPY and EUR and most other currencies - because the (public) debt problem is already past the point of no return in some economies. This doesn't mean the price of gold will explode tomorrow in my opinion - but as soon as a debt bubble "pops" in a large economy somewhere.

Then again, I'm not named Krugman and didn't get a Nobel Prize in Economics. If this article made you uncomfortable, take your blue pill and safely return to the land of CNBC and Krugman; the latter writes:

This is how you want to think about debt: it's not a burden on the nation's resources, because it's mainly money we owe to ourselves, and it's a problem not because we have to tighten our belt but because debt is currently leading to spending that's less than we need to maintain full employment.

I am not witty enough to understand these "left pocket, right pocket" balance sheet explanations Krugman seems to imply, so I can't explain them here. At least I'm not the only one having issues understanding:

Krugman's debt theory fails for the same reason that his government-spending stimulus theory fails. He sees us in the aggregate, not as individuals. This is why he can claim that "every dollar's worth of foreign claims on America is matched by 89 cents' worth of U.S. claims on foreigners" as if it all just nets out. What he does not mention is that each of us is affected differently.

When someone buys a government bond, it is a voluntary market transaction. The buyer voluntarily gives up current resources for use by the government. There is no symmetry for taxpayers, especially those in future generations. For those who bear the burden of current and future taxation, the transaction is not voluntary.

This Instablog entry was merely an answer to a recent SeekingAlpha article published here:

Ron Paul Has It Totally Backwards, Gold Isn't Going To Explode Higher

As you can imagine, I strongly object to the findings of that article, also because the words "debt" or "public debt" were not mentioned once in the text. I think it's impossible to discuss future gold prices without taking into account fiat money debt levels around the world.

Summary: Gold Prices and (Public) Debt Levels are closely linked - when a debt bubble will explode in a major fiat currency (that's more a matter of when than if in my opinion) gold prices will likely explode.

PS: I'm aware some people advocate holding only physical gold (and/or other metals). I nevertheless linked to the two most prominent gold ETF symbols in this article. Do your own diligence and decide what's best for you in your personal situation.


* An intelligent man named Kyle Bass has explained this ad nauseam. I will simply link to his findings in a recent interview rather than rehash the debt problem in Japan in more detail myself:

Beacon Reports: Japan is not Greece. It is a rich developed nation. The Japanese are educated, organized and hard working. The country's infrastructure - roads, buildings, bridges, factories, trains - are in better shape than most other developed nations. A shinkansen departs every ten minutes and they run on time. The country enjoys reserve currency status. Why should Japan be the first developed nation to mark the beginning of the end of the 70-year debt supercycle?

Kyle: You need to divorce yourself from preconceived ideas. I've never met a more gentle, considerate, welcoming, thoughtful, or spiritual population in any other country in my lifetime. Japan is a beautiful country and its people are great. That's beside the point. The point is the government has mismanaged its finances to an extent where they have moved the country into a checkmate.

The reason why Japan is going to be first is that they spend 50% of their central government tax revenue on debt service alone. They are near the point where they just can't borrow anymore. Further, the Japanese would rather not admit wrongdoing: They never restructured their banks during the post late 80s - early 90s collapse. They've taken rates to zero. Their economy has continued to move along for the past 10 - 15 years because it was export based. That's changed − there is nowhere to go.

Japan's trade surplus is negative. The balance of trade is negative. The current account is moving into a negative position. The demography of the country is unstoppably rolling over. It's a multivariate equation in which everything is working against the government at the same time. Kuroda and Abe have only one way to go - and that's to go all in - which is what they did.

** FRB opens yet another can of worms, this can't be discussed at length here. I will reserve the important FRB issue for a later article. That's when you will have to swallow the giant red pill :)

Disclosure: I am long GDXJ, IAU.