currency – Dennis Tubbergen

Debt Truths

A seldom-discussed topic that has a significant economic impact is private sector debt levels.

Ever since 1971, when the US Dollar became a fiat currency, and new currency has been created by loaning it into existence.

If banks have a 10% reserve requirement, a $100,000 deposit into a bank can be transformed into $1,000,000 if the velocity of money is high enough.

For example, say you deposit $100,000 into your bank. Your banker reserves 10% or $10,000 and loans out the other $90,000. Say the borrower of the $90,000 buys an expensive car and borrows the $90,000 now available from your bank to do so. The car dealer deposits the $90,000 into her bank. That banker reserves 10% or $9,000 and loans out the other $81,000. That process continues up to a maximum of new currency created of $1,000,000.

Historically, when the Federal Reserve wanted to jump-start the economy by increasing the currency supply, the central bank would reduce interest rates to increase the velocity of money, thereby creating more currency.

That worked until the time of the financial crisis when interest rates were reduced to zero, but lending did not follow due to the fact that, collectively speaking, the American public was already deeply in debt.

It was at that point the Federal Reserve made the decision to ‘temporarily’ pursue a program of quantitative easing or currency creation. As we all now know, the program continued long past the time that a reasonable person would say it was temporary.

As I have often stated, it is my belief that this program will once again be revived in earnest, although it will likely be called something other than quantitative easing.

Since the time of the financial crisis, this policy of currency creation has caused debt levels to increase immensely. At the time of the financial crisis, worldwide debt was about $100 trillion. It now stands at $300 trillion – a truly remarkable number.

Presently, debt levels are continuing to increase. The data shows that consumers are increasingly taking on new debt to cope with rising living costs. This from “Zero Hedge” (Source: https://www.zerohedge.com/markets/consumer-debt-soars-394bn-most-20-years-record-169-trillion-young-borrowers-struggle-repay):

While it won’t tell us anything we don’t know – since it is two months delayed and we already get monthly updates from the Fed via the G.19 statement – this morning, the NY Fed published its quarterly Household Debt and Credit report, which showed that total household debt in the fourth quarter of 2022 rose by 2.4% or $394 billion, the largest nominal quarterly increase in twenty years, to a record $16.90 trillion. Balances now stand $2.75 trillion higher than at the end of 2019, before the pandemic recession.

And the same chart broken down by age:

Every type of consumer credit increased in Q4, and here is a detailed breakdown:

Mortgage balances rose by $254 billion in the fourth quarter of 2022 and stood at $11.92 trillion at the end of December, marking a nearly $1 trillion increase in mortgage balances in 2022.
Home equity lines of credit rose by $14 billion to $340 billion.
Student loan balances now stand at $1.60 trillion, up by $21 billion from the previous quarter. In total, non-housing balances grew by $126 billion.
Auto loan balances increased by $28 billion in the fourth quarter, consistent with the upward trajectory seen since 2011.
Credit card balances increased $61 billion in the fourth quarter to $986 billion, surpassing the pre-pandemic high of $927 billion.

There is an eternal truth about excessive debt accumulation – if there is too much debt to be paid, it won’t be paid.

This is true regarding private sector debt and it is true as far as government debt and liabilities are concerned as well.

It is my view, based on simple math, that debt levels are now past the point of no return and are now too high to ever be paid.

The result, at some future point, will be a massive deflationary environment that will, in my view, resemble the 1930’s; or, possibly, worse.

Looking at the first chart above, one can see the combined debt total of mortgage debt, home equity loan debt, auto debt, student loan debt, and credit card debt is now about 1/3^rd higher than at the time of the financial crisis.

Alarmingly, debt levels have grown the most among those over age 60. That, at least in my view, indicates that consumers are increasingly relying on debt to make ends meet in what is a very difficult economy.

And, to add insult to injury, the most recent inflation numbers indicate that inflation is not under control. This was not at all surprising to me. As I have been stating, the Fed isn’t doing enough to get inflation under control.

Inflation will not be controlled until we have real, positive interest rates – something we are a long way away from.

In the meantime, the US economy (and the world economy) is heading for a time of painful stagflation.

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What is Real and Where are We Heading?

While I don’t typically publish the databox above in my blog each week, I am including it this week for reference.

The Dow to Gold ratio continued to fall last week. As currency devaluation continues, this is an indicator that becomes more meaningful in my view.

If you are not familiar with the Dow to gold ratio, it is simply the Dow Jones industrial average priced in gold. The Dow to gold ratio began the year at about 20 and it currently stands just under 16 1/2. That is a decline in stocks when measured in gold of almost 18%.

To calculate the Dow to gold ratio, one takes the value of the Dow priced in dollars and divides by the price of gold per ounce also priced in dollars. The current value of the Dow, 32,944.19 divided by the price of gold per ounce of 1999 results in a doubt to gold ratio of 16.48.

As currency is devalued, the nominal value of stocks increases. That can result in the illusion of an appreciating stock market when the reality is a depreciating currency, not a stock market that is increasing in real terms.

If we go back to the beginning of calendar year 2000, we find that the Dow Jones industrial average was at about 11,500. Presently, the Dow is nearly triple that level.

The question is, does that mean stocks have tripled in value, or does it mean that the US Dollar just buys a lot less?

By pricing the Dow in gold, we can get an idea.

In January of 2000, gold was selling for about $280 per ounce. To price the Dow Jones Industrial Average in gold, one would take the value of the Dow, 11,500 and divide by the price of gold per ounce, $280, resulting in a Dow to gold ratio of about 41.

In other words, if you were going to use gold to buy the Dow instead of US Dollars, you’d need 41 ounces of the yellow metal to own the Dow. (You can’t actually buy the Dow, but this is a good comparison.)

Today, the Dow is at about 33,000 and the price of gold per ounce is about $2,000. Taking the value of the Dow and dividing by the price of gold per ounce, one finds that the Dow to gold ratio is 16.5. In other words, 22 years later, stocks when priced in gold have fallen nearly 60% while the same stock index priced in US Dollars has nearly tripled.

While that comparison may not conclusively answer the question posed above, another example may.

According to the United States Census Bureau, the median price of a home in calendar year 2000 was $119,600. (Source: https://www.census.gov/data/tables/time-series/dec/coh-values.html)

If you were using gold to buy the new home in calendar yar 2000 rather than US Dollars, a new home would have set you back about 427 ounces of gold.

Fast forward to today and the National Association of Realtors reports that the median price of a home is $358,000. (Source: https://www.newhomesource.com/learn/cost-to-build-house-per-square-foot/) Given that gold is about $2,000 per ounce, a new home could be had for about 179 ounces of gold.

Like stocks, home values have roughly tripled in the last 22 years when priced in US Dollars. But, priced in gold, real estate values have declined just like stock values.

This brings me to my point this week, in real terms (gold) we are experiencing deflation. Measured in US Dollars we have inflation.

As I discussed on my “Headline Roundup” webinar this week, Egon von Greyerz had some great observations along these same lines last week. Here is a bit from his article (Source: https://goldswitzerland.com/global-monetary-commodity-inferno/):

Inflation leading to hyperinflation was always guaranteed in the current debt-infested era, although the Fed and other Western central banks have never understood what inflation is. Just as they didn’t understand that their fake and manipulated inflation figures couldn’t even reach the Fed target of 2%. Now with real US inflation exceeding 15% (see graph below), the Fed has a new dilemma that they are totally unprepared for.

The US government conveniently changed the calculation of inflation to suit their purpose. Had they stuck to the 1980s established method, official inflation would be over 15% today and rising.

For years, the US Fed unsuccessfully tried, with all the king’s horses and all the king’s men, to get inflation up to 2%. In spite of throwing $ trillions at the problem and keeping interest rates at zero, they never understood why they failed.

In spite of printing unlimited amounts of counterfeit money, inflation for years stayed nearer 0% than 2%.

Now with official inflation at 7% and real at 15%, the Fed can’t understand what has hit them as we know from their laughable “transitory” language.

So now a quick volte-face for the Fed to figure out how to reduce inflation by 5 percentage points and more likely by 13 to get inflation down to 2% instead of up to 2%.

Clearly, the Fed can never get it right but many of us have known that for a very long time.

If the Fed studied and understood Austrian economics rather than defunct Keynesianism, they would know that the real inflation rate depends on growth in money supply rather than the obsolete consumer price model.

So let’s take a look at the growth in Money Supply. Since 1971, M2 has grown by 7% annually. A 7% growth means that prices double every 10 years. Thus 100% total inflation over 10 years rather than the 2% per annum that is the Fed target.

But as the chart above shows, the exponential phase started in March 2020 with M2 growing by 19% annually since then. That means a doubling of prices every 3.8 years.

Since the money supply is growing at 19% annually, this means that inflation is also 19% based on our Austrian friends.

And this is what the US and the world were facing before the Ukraine crisis. But now there is a lot of explosive fuel being poured on the global inflation fire.

Russia has the biggest natural resource reserves in the world which include coal, natural gas, oil, gold, timber, rare earth metals, etc. In Rubles, these reserves will obviously appreciate substantially with the falling currency.

In total, the Russian natural resource reserves are estimated at $75 trillion. That is 66% higher than the second country USA and more than twice as much as Saudi Arabia and Canada.

Even if the total Russian supply is not lost to the world, it is clear that the West is determined to punish Russia to the furthest extent possible. Therefore, as we have already seen in the major escalation of oil and gas prices, the shortages will put insufferable pressure on the prices of natural resources.

I have for quite a few years warned about the coming inflation, leading to hyperinflation, based on unlimited money printing.

But the dynamite of a global commodity crisis and shortages thrown into the already catastrophic debt and global monetary fire will create an inferno of nuclear proportions.

If a miracle doesn’t stop this war very quickly (which is extremely unlikely), the world will soon be entering a hyperinflationary commodity explosion (think both energy, metals, and food) combined with a cataclysmic deflationary asset implosion (think debt, stocks, and property).

The world will be experiencing totally unknown consequences without the ability to solve any of them for a very long time. All the above would most likely happen even without a global war. But if the war spreads outside Russia and Ukraine, then all bets are off. At this point, I am not going to speculate about such an outcome since what is standing in front of us currently certainly is bad enough.

Inflation and Deflation Perspectives

Despite last week’s rally in stocks, the highs of mid-November remain the market’s high point. As I have been noting, my long-term, trend-following indicators remain negative.

This past week, I began to read the most recent book by James Turk, a past guest on my radio program. Mr. Turk’s book is titled, “Money and Liberty; in the Pursuit of Happiness and the Natural Theory of Money”.

In the book, Mr. Turk offers a perspective similar to the perspective I have offered in the past regarding money and currency and the difference between the two. Currency is used in commerce and money is a good store of value over time. Sometimes in history, currency and money have been the same thing, other times, including the present time, they are not the same thing.

Mr. Turk offers the example of West Texas Intermediate crude oil. When a barrel of oil is priced in US Dollars, Euros, or the British Pound, one concludes that the price of crude oil has risen significantly since 1950.

However, when priced in gold grams, the price of a barrel of crude oil hasn’t changed since 1950.

Fiat currencies, over time, are devalued by central banks or governments. That makes fiat currencies poor measuring units.

Economic output, or gross domestic product, is measured in fiat currencies. Devalued currencies make the reported economic output number look better than it is in reality.

The same is true when it comes to stock values. Stock prices reported in fiat currencies move up as the currency is devalued. The same devalued fiat currencies that make the price of consumer goods like groceries rise also make the price of stocks increase.

Historically speaking, this devaluation of currency is controlled and gradual initially, but then the politicians and policymakers lose control of the devaluation process and inflation gets out of control.

Economist John Meynard Keynes, the father of the loose money policies that are being pursued worldwide today, knew that control over the devaluation process would eventually be lost with dire consequences.

In 1923, Keynes wrote a tract on monetary reform. The second chapter of the tract is titled, “Inflation as a method of taxation”. Keynes, in his writing, discusses devaluation of a currency or inflation as a method of taxation that allows a government to survive when there is no other means of survival. This from his tract (Source: https://delong.typepad.com/keynes-1923-a-tract-on-monetary-reform.pdf):

A government can live for a long time, even the German Government of the Russian Government, by printing paper money. That is to say by this means, secure the command over real resources – resources just as real as obtained through taxation. The method is condemned, but its efficacy, up to a point, must be admitted. A government can live by this means when it can live by no other. It is the form of taxation which the public finds hardest to evade and even the weakest governments can enforce when it can enforce nothing else.”

Keynes indirectly states that the positive effects of currency printing diminish over time when he states that “its efficacy, up to a point, must be admitted.”

Keynes clearly understood that in the long run, the point is reached when currency devaluation doesn’t work and the adverse consequences of currency creation emerge. One of Keynes’ most infamous quotes is “in the long run, we are all dead.” Keynes clearly understood that eventually, this monetary policy would fail but it would be long after he and his cohorts exited the planet.

Mr. Turk, in the aforementioned book, has this to say about Keynes’ statement.

“These words, which are frequently quoted, are among the most grossly irresponsible statements ever spoken by an economist. Actions have consequences and planning for the next generation is an essential element of economic activity. What is important to society and indeed our civilization is not just how we live, but what we leave for future generations. That the planet’s environment has become so scarred is an indication of how much we have accepted the ills of progressivism, socialism, and authoritarian control by the State and moved away from capitalism, private property, and individual liberty. The State today rarely leaves people alone.

Keynes’s comment is typical of socialists and progressives who focus on satisfying their innate yet perverse need to control others rather than where their attention should be directed, which is the consequence of their actions. For example, they proclaim their vision that forces the world to drive electric cars so that we do not inhale the emissions from exhaust pipes, yet they are blind to the number of plants needed to generate the electricity to power all those new cars. Decisions cannot be made on emotion. In our world of limited resources, they must be made based on sound economics and that requires trustworthy money spent and invested at a true cost of capital. These are requirements that only gold can provide. Further, to achieve the best possible outcome decisions need to be unfettered by government involvement and their market interventions.

For Keynes, the long-run has arrived, and he wrote his own fitting epitaph:

‘Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist. Madmen in authority, who hear voices in the air are distilling their frenzy from some academic scribbler of a few years back.’

It’s time to bury Keynes, Keynesianism, and socialism.”

I agree with Mr. Turk.

But abandoning currency creation will come at a cost. A deflationary period of time will materialize. Continuing with the Keynesian policies of currency creation will not avoid the deflationary period, it will only make the eventual deflationary period worse.

The choices are grim; an ugly deflationary period, or an uglier deflationary period. The longer currency creation continues, the more severe the resulting deflationary period will be. Keynes touched on this in his 1923 tract:

“In the first place, deflation is not desirable because it effects, what is always harmful, a change in the existing Standard of Value, and redistributes wealth in a manner injurious, at the same time to business and social stability. Deflation, as we have already seen, involves a transference of wealth from the rest of the community to the rentier class and to all holders of titles to money; just as inflation involves the opposite.”

“But, whilst the oppression of the taxpayer for the enrichment of the rentier is the chief, lasting result, there is another more violent disturbance during the period of transition. The policy of gradually raising the value of a country’s money to (say) 100% above its present value in terms of goods, amounts to giving notice to every merchant and every manufacturer, that for some time to come his stock and his raw materials will steadily depreciate on his hands and to everyone who finances his business with borrowed money that he will, sooner or later, lose 100% on his liabilities. Modern business, being carried on largely with borrowed money, must necessarily be brought to a standstill by such a process.”

If you’re not familiar with the term ‘rentier’ class, it refers to someone who relies on a pension, rents, or other fixed-income sources.

These people benefit from a currency that buys more over time.

On the other hand, borrowers benefit from a currency that buys less over time. Mortgage holders, business owners with debt, and the government all benefit from a currency that is being devalued. In this scenario, dollars borrowed, buy more than dollars that are used to pay back the debt.

When Keynes fails to acknowledge in his 1923 tract is constant money.

Gold is constant money.

When we go back and revisit the example of West Texas Intermediate crude oil that Mr. Turk used in his book, we find that the barrel of crude oil that sold for $2.57 in 1950 now costs more than $70 to purchase when using US Dollars in the transaction.

That barrel of oil purchased with gold grams in 1950 and today would cost the same amount. Gold has historically been constant money.

At different times in history, the paper currency has been only partially backed by gold which allows for more currency creation and is inflationary.

Today, there are zero currencies in the world with any level of gold backing. Currency creation worldwide has been expanding and consumer price inflation is now manifesting itself in earnest.

In response, many world central banks are raising interest rates to attempt to suppress inflation. Wolf Richter (Source: https://wolfstreet.com/2021/12/22/end-of-easy-money-global-tightening-in-full-swing-fed-promises-to-wake-up-in-time/) reported last week that the central banks of Czechoslovakia, Russia, England, Norway, the European Central Bank, Mexico, Chile, Hungary, Pakistan, Armenia, Peru, Poland, Brazil, Korea, New Zealand, South Africa, Iceland, and Japan have all increased interest rates.

The Fed has kept interest rates at zero; look for more inflation before we see deflation.

As for Keynes, he was right about being dead in the long run. Keynes passed away in 1946.