The United States has experienced high rates of inflation in the past and appears to be running the same type of fiscal policies that engendered hyperinflations in 20 countries over the past century. - Laurence Kotlikoff
I’ve been concerned about a hyperinflationary environment for close to a decade. My thought process is rather simple.
There is a significant amount of debt in the system that continues to increase every year.
Politicians use a short-term view point when it comes to spending. If you want to get reelected you need to spend, spend, spend. No one will get reelected if they tighten up the budget during their time in office.
The United States monetary system operates under a fiat currency. The only “thing” giving the U.S. Dollar value is the full faith of the citizens who use it. If this faith in the monetary system collapses, the dollar will become utterly useless.
No fiat currency in the history of monetary history has stood the test of time. Every fiat currency ends up collapsing under the weight of inflation.
Money printer go brrr.
I’ve tried to position my portfolio and personal assets to withstand a potential inflationary environment. I mainly own companies with real assets (real estate, land, buildings, equipment). The majority of my portfolio is in asset rich, unlevered companies. And I have started to accumulate physical gold.
The level of Federal debt concerns me. I am under the belief that this debt will eventually need to be paid. The payment of the Federal Debt will either be done through:
Spending cuts
Higher taxes
Inflation
I’m under the impression that spending cuts will likely not happen. Government officials, especially Presidents with four year terms, have incentives to keep spending rapidly in order to boost their own presidential rating and ensure they are reelected when their first term is up. Nobody ever votes for a President who cuts spending.
Higher taxes is definitely a possibility. Biden is already making plans to leverage the debt burden by raising taxes. But there is only so much a government institution can raise taxes to before it upsets the populace. If a government institution raises taxes too much it could result in riots, angst and potentially a Coup d'état.
Since a massive spending cut and higher taxes is likely not to happen the only way to pay off the Federal debt the United States has accumulated is through inflation — the invisible tax. And this has already begun.
Did you know that 22% of all U.S. Dollars were created in 2020 alone? Read that again. 1/5th of all U.S. Dollars were created in 2020.
On December 2020 there were $15.4 trillion dollars in the world. At today’s date, there are $19.7 trillion dollars. In layman’s terms this is described as printing money. But in practice the Fed creates digital dollars to buy government bonds in the secondary market, known as quantitative easing. The buying of government bonds keeps bond prices high and yields low.
The federal funds rate is currently at historical lows (pretty much at zero) from the massive injection of cash into the bond market. Basically, the majority of the new money pumped into the system went directly into the bond market.
But how can you blame them? Federal debt levels have skyrocketed — now over $27 trillion — up from $23 trillion at the beginning of 2020.
Assuming the interest payment on the $27 trillion of Federal debt is 0.07% this implies the yearly interest payment is $18.9 billion. But what if we assumed the interest rate started to move? We mapped the potential annual interest obligations out below:
1% - $270 billion
2% - $540 billion
3% - $810 billion
4% - $1.08 trillion
5% - $1.35 trillion
6% - $1.62 trillion
7% - $1.89 trillion
8% - $2.16 trillion
9% - $2.43 trillion
10% - $2.70 trillion
15% - $4.05 trillion
20% - 5.40 trillion
The United States is in big trouble if interest rates move. A move to a measly 3% interest rate implies the yearly interest payable would be around $810 billion — a 4,185% increase from the current rate.
But what if inflation gets out of control, bonds are sold off and interest rates move back to the levels we saw in the 80s? Annual interest payable on $27 trillion in debt would be in the trillion dollar range.
But, but, but Federal Reserve economists say inflation will be “transitory”.
Transitory…
A word usage that tells investors that the Fed has gotten so deep into Project Zimbabwe the only word they have to describe the impending inflation is transitory.
Even the “Bond King” himself thinks the Fed has lost all control.
“I’m not sure why they think they know that it’s transitory,“ Gundlach of DoubleLine Capital LP said in an interview with BNN Bloomberg Tuesday. “How do they know that when there’s plenty of money printing that’s been going on and we’ve seen commodity prices going up really massively.”
“There’s plenty of indicators that suggest that inflation is going to go higher, and not just on a transitory basis, for a couple of months. So we’ll see how the Fed is trying to paint the picture, but they’re guessing.”
“Who’s going to buy all these many trillions of dollars of bonds? Foreigners have been selling for years and they’ve accelerated their selling in the last several quarters, domestic buyers are not exactly selling, but they’re not adding to their holdings. So what’s left to absorb all of the spawn supply is the Federal Reserve.”
Does transitory mean seeing the price of corn limit up everyday to now trade above $7.00?
Or how about the price of wheat which is now trading at an eight year high?
Or what about literally every commodity screaming to new all time highs? Is this purely transitory?
The point I’m trying to make is the Federal Reserve has experimented with this cheap money for far too long and eventually there is a point of no return. The entire global economy is awash in debt and inflation is starting to happen.
If inflation happens in a major way, the real interest rate on bonds will collapse into negative territory (I’d argue they are already there) and bonds get sold off. When bonds get sold off interest rates explode higher. The only thing holding interest rates down is the Fed’s massive quantitative easing practices. I can’t imagine any astute institutional investor is buying bonds at less than a 1% rate.
Some think interest rates will be at this level forever because the Fed can’t afford to let rates move higher. I’d argue that eventually free market forces will force the Fed to show its hands resulting in a global currency crises the world has never seen before.
For this reason alone I have been accumulating physical gold. I only have 3.5% of my portfolio in physical gold but targeting at 6-8% rate in the near-term. And I’m not thinking of this gold accumulation as an investment, but more of an insurance policy. An insurance policy against the reckless monetary decisions world government have adopted. My gold position is a short against the entire system.
It’s not really an investment per se—It’s an escape from government imprudence. You don’t own gold because you expect it to do remarkable things—you own it because you are scared of your government doing remarkable things. Think of gold like the credit rating of world governments. It’s the CDS you buy if you don’t trust the politicians and their stewardship of the currency. - Kuppy, Adventures In Capitalism
Short list of countries that have underwent hyperinflation (this list is not comprehensive):
France 1795-1796
Austria 1921-1922
Soviet Union 1921-1922
Germany Weimer Republic 1922-1923
Poland 1923, 1989-1990
Greece 1941-1944
Philippines 1944
Malaya 1942-1945
Hungary 1945-1946
China 1943-1949
Bolivia 1970-1987
Chile 1971-1981
Argentina 1975-1992
Brazil 1985-1994
Peru 1988-1991
Yugoslavia 1989-1994
Angola 1991 – 1999
Yugoslavia 1992-1995
Belarus 1994-2002
Zimbabwe 2000-2009
North Korea 2009-2011
Venezuela 2016
One of my favorite books is Gone With The Wind. It is an incredible story of riches to rags and back to riches. A part in Gone With The Wind that really stands out to me is when the rich southern farmers lose all of their money because they held their wealth in Confederate currency that underwent a hyperinflationary state during the war.
After the war the ones who owned gold became extremely wealthy and in some cases were hunted down by the government so they could confiscate their wealth.
"I've made enough money, and it's in English banks and in gold. None of this worthless paper for me." - Rhett Butler, Gone With The Wind
The end game is simple to me. The U.S. fiat currency will eventually collapse and you will want to be holding a real asset than can’t be diluted into oblivion. I choose gold as my short against the entire system.
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Love reading your letter! If gold is a “store of value” how do you view crypto specifically Bitcoin? My personal research suggests Bitcoin could be a store of value while other altcoins provide value in different ways. Do you think we could a run on Bitcoin similar to gold of inflation rises?
6 to 8% position based upon the backdrop would be extremely low. Better than most, however not enough IMO!