Investors in U.S. debt around the world are worryingly near a "psychological breaking point" that could force a "run on the bank" against Treasurys.
If that happens, hyperinflation quickly follows and gold will soar much, much higher from its now record-setting levels, argues author and longtime trader Victor Sperandeo in the latest issue of Barron's. Sperandeo has traded for many top investors including George Soros.
Anyone who believes that the United States faces a comparatively mild 1970s-style inflation risk is ignoring history at his own peril, Sperandeo writes in the weekly investment newspaper.
"Unlike normal inflation, which may be attributed to a variety of factors, hyperinflation has a single cause: It occurs when a government cannot borrow money because its debt has risen so much that investors believe they will never be paid back with close to the same purchasing power," he writes.
Historically, he writes, investors lose confidence in government debt when borrowing hits 40 percent of spending over an extended period of years. The telltale sign will be non-annualized inflation of 50 percent or more in a single month.
In 2009, the author notes, the deficit was 44 percent of spending, although not all of it was borrowed. It happened again in 2010. U.S. debt is now more than $13.7 trillion (not counting state and agency debts) and deficits are running $1 trillion a year.
"A nation needs to inspire a lot of confidence to keep that Ponzi scheme alive," Sperandeo writes.
"Unfortunately, markets know that even the U.S. government will print money to meet expenses when necessary."
The key is the gap between the rate paid investors to own Treasury debt vs. the inflation rate. If that narrows by too much, there is no longer any compelling reason to hold the debt. Foreign investors then dump U.S. bonds in a rush not to be left holding the bag.
Right now, Sperandeo points out, 30-year Treasury bonds pay 4.21 percent. Inflation might be low, but it has averaged 4.12 percent over nearly a half-century. Foreign holders of U.S. debt know perfectly well how tiny that return gap is and how fast it can turn into a loss.
"This leads to the question, being asked from Beijing to Brussels: Does the risk match the reward? A negative response to that question could lead to hyperinflation," writes Sperandeo.
"Potentially, investors in U.S. debt will begin something similar to a run on the bank, selling Treasurys, even at severe losses."
If hyperinflation takes hold, expect gold to run quickly higher, Sperandeo writes. In hyperinflation, the metal can gain between 2,000 percent and 50,000 percent in value against a hyperinflated, collapsing currency.
Meanwhile, a retiring member of the policy committee of China's central bank has reiterated his call for China to cut its holdings of U.S. Treasurys in order to minimize losses on its foreign-denominated exchange reserves.
According to press reports, Yu Yongding made the renewed call to dump U.S. debt and move the yuan toward market-driven exchange rates in an opinion piece in Caijing magazine.
Allowing the yuan to float would help China wind down its massive dollar-asset holdings, Yu argued.
"China should strive to reduce instead of further increasing (its holdings of) dollar assets," he said. "Specifically, China should reduce the growth of its foreign-exchange reserves as soon as possible."
As recently as July, Yu had called for Beijing to sell off U.S. Treasurys. He believes that continued U.S. fiscal measures to stave off recession will ultimately weaken the dollar, causing China's estimated $2.65 trillion in dollar holdings to quickly lose value.
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