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When Push Comes to Shove, Central Banks Print

Inflation is always and everywhere a monetary phenomenon– Milton Friedman

With worldwide demand for oil ebbing [.5% growth in ’11 and .3% since ’08 (compound annual growth rate – CAGR)], and with huge new discoveries, it would be logical that the price of related commodities would be falling. The price of gasoline, for example, is currently 2.3 times its $1.61/gallon low of four years ago. The price of gold, while down from its peak, is still much higher than its $1,100/oz price at that time.

The question: Why have the prices of these hard assets risen so rapidly despite high unemployment, weak demand, and excess capacity in the economy? To answer this question, one must understand the underlying structural issues facing the U.S. and the developed world, and the responses to these issues from governments and central banks.

Structural Budget Issues

The National Debt of the U.S. currently stands at $16.5 trillion, and unless current economic growth improves dramatically, and soon, the actual National Debt is likely to be closer to $22 trillion by 2017.



(millions $)


2013 Spending Estimate

% of 2013 Federal Spending


2017 Spending Estimate




% of 2017 Federal Spending







Social Security












Income Security




No change


Interest on Debt






Federal Pensions




At current rate







Tax Collections






The table shows estimates of spending for the six largest federal expense categories using USDebtclock.org 2013 estimates and CBO estimates for 2017. The issue is that these six categories eat up 100% of total tax collections even under CBO’s optimistic set of assumptions. On top of these six categories is the cost of the other functions of government including all of the internal departments (DOJ, Homeland Security, EPA, Commerce, Interior, State, etc.) and the off budget expenses of the agencies (FNMA, FHA, GNMA, FHLMC, Post-Office, Amtrak, etc.).

The Debt Cost Issue

In Japan, the Debt/GDP ratio is more than 200%, and the interest cost of the debt is 20% of tax collections. The coupon cost of the debt is about 1%. If rates rose to 3%, 4%, or 5%, the cost of their debt would rise to 60%, 80%, or 100% of their tax collections. Clearly, they could not allow this to happen, and either default or massive inflation would occur. Interestingly, Japan has embarked on a massive money printing scheme and has compromised the independence of its central bank in the process.

Using the maturity structure of the existing U.S. Treasury marketable debt, the table below shows estimates of what would happen to the cost of the debt in five years under different rising interest rate scenarios. A return to a “normal” interest rate structure may truly be a budget busting event.


Yield Curve Rises By

Change in Cost (bill $) if Debt is $22 Trillion Total Interest Cost (bill $) (CBO + Change Due to Yield Curve Shift) Total Interest Cost as a % of CBO Estimated 2017 Tax Collections

200 bps




300 bps




500 bps




700 bps




The Real Budget Deficit Issue

On January 17, the U.S. Treasury announced that the deficit for the 2012 fiscal year, using Generally Accepted Accounting Principles (GAAP) was $6.6 trillion, of which $5.3 trillion was the net present value of the future promises that were made in 2012 alone. This isn’t really a surprise, as the GAAP deficits have been in excess of $5 trillion since the Recession. Unfortunately, the number is simply ignored by the media and the markets. Due to demographics, such annual promises will only increase under the current social programs in the U.S. for the next ten years. The structural deficit is most likely the most critical economic issue of our time.

Scary Scenario

We all hope that the economy picks up, the unemployment rate falls, and that economic growth returns to a more normal pace. But, if that doesn’t soon happen, investors, both foreign and domestic, may begin to lose faith in the dollar as the world’s reserve currency, and, despite an under performing economy, demand higher interest returns. This type of scenario is what played out in Europe in 2011-2012 when rates rose on the debt of Greece, Portugal, Spain and Italy. Note that the European Central Bank rode to the rescue of the European Union periphery by printing tons of money and by purchasing the debt of the above named countries.

Here is the dilemma: If interest rates rise back to normal levels, the cost of the debt becomes a huge issue, especially if the economy is under performing. In the U.S., add to that the inability to control the debt issuance due to the structural problem outlined above. Those issues keep the Deficit/GDP ratio high and start a death spiral of ever rising rates which chokes the economy. And, as we saw in Europe last fall, the only relief that will satisfy the capital markets (i.e., the “bond vigilantes“) is a massive money creation.

For politicians, inflation via money printing is the easiest choice even if it means a subjugation of the independence of the central bank to the government’s will, as we are witnessing in Japan. Gold and other hard assets have, over the last few years, also been influenced. The precedents have clearly been set both in Europe and Japan. When faced with the choice of higher rates or money printing in an under performing economy, it is clear what the choice will be.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs. Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.


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