October marks the beginning of the fiscal year for the U.S government and a chance to think ahead to the overall direction of our new season.
While the year technically ends in December, I’ve always felt the year really begins anew in the beginning of fall. Autumn is a time for new beginnings that come from the changing seasons. Kids go back to school, businesspeople turn in their beach novels for briefcases, and the football season starts in earnest (my beloved Eagles are 10-1 shot to repeat as champions).
The “seasons,” when considering overall government debt, are better viewed in periods of years rather than months. As a country we are now over $21 trillion in debt, and counting.
According to the Congressional Budget Office (CBO) the recently passed tax cuts will add over $1.5 trillion to our debt and we will likely have deficits of over $1 trillion in each of the next four to five years. Estimates indicate that the U.S. government could be in excess of $30 trillion in debt by the year 2027.
We have become so numbed by this astronomical level of debt that adding “trillions” seems like just a number. What’s another $10 trillion in the overall scheme of things? Some people have even argued that “deficits don’t matter” and that the “debt is just a number and nothing to be concerned about.” They are wrong.
The key to understanding debt, is that it is not the level of debt that should be most concerning, it’s the growth in interest costs. While these trillion dollar numbers are impossible to imagine, the math is ultimately quite simple.
In 2008, the U.S. was $10 trillion in debt. The “cost to service” the interest on our national debt in 2008 equaled $451 billion per year. At the end of fiscal year 2017 we were over $20 trillion in debt, yet we paid $458 billion in interest payments. Notice that we were able to double the total debt without having any impact to the cost of servicing it. This magic trick has been accomplished through financial engineering. The Fed lowered rates and the U.S. government has continued to refinance our debt at lower costs. In 2008 we paid about 4.5% in interest expense on our national debt. At the end of 2017, that number was closer to 2.25%.
As you can see, it’s not the overall debt that matters, it’s the “cost of carrying it.” This is why anyone who argues “deficits don’t matter” simply doesn’t understand the big picture.
“The dollar has remained strong and our deficits haven’t mattered” is a more accurate statement looking back on the last 10 years. That “season,” however, has ended and new season has begun.
If you are going to bet on one thing (other than the Eagles to repeat as champions), bet on this, the next decade will look nothing like the last when it comes to our national debt and the long term value of the U.S. dollar.
The Ponzi scheme of refinancing debt at lower rates has ended. In fact, the numbers are hot off the press for fiscal year 2018. Drumroll please. The U.S. had a whopping budget deficit of $898 billion this past year and has added roughly $45 billion to the overall “cost” of servicing our debt. The current tab on our $21 trillion debt currently stands at $506 billion per year. This is just the beginning. The 10-year Treasury now hovers at about 3%. New debt issuance over the coming four to five years will not be financed at lower rates of closer to 2%. The Fed’s forward guidance and dot-plots suggest that the 10 Year Treasury rate will be north of 4% in the next 12-18 months, with some experts even predicting rates will reach as high as 6% by 2021. This means that all the new debt, as well as the debt the Fed is “rolling over” will cost significantly more to service in the form of higher interest payments in the coming decade. The CBO agrees and projects that these costs will skyrocket in the coming years forcing more and more of our budgets to go towards servicing the national debt.
For perspective, the last season where costs to service debt increased was from 2003-2011. During this time our national debt rose by $7 trillion and our cost of servicing that debt rose from $318 billion in 2003, to $454 billion in 2011. That amounts to a 50% cost increase to service debt over a nine year span. Deficits surely mattered then. The U.S. dollar depreciated significantly during this period.
When glimpsing the future through this lens, the U.S. dollar could be in some very big long-term trouble. The projections of the CBO tell us that the cost to service our national debt could as much as double over the next decade, going from $458 billion in 2018 to over $800 billion in 2027. This projection does not include what would happen should we be faced with a financial crisis during this time, where the Fed would need to ramp up overall debt to keep the economy out of a long-term recession. If we simply stay on our current course, we can expect massive pressure from the cost to service our debt. If the course gets rocky at all it could become far worse.
As the dollar lost value, gold prices soared. In 2003 the price of gold was $400 per ounce. Eight years later gold was $1,600 per ounce. The U.S. dollar was pressured by the massive overhang of rising debt service cost. When the dollar gets pressured like this, it devalues and tangible assets like gold over-perform.
Doesn’t it seem reasonable that if the cost to service our debt grew by 50% from 2003-2011 and gold prices quadrupled, that if the cost to service our debt doubles in the coming years that gold could go up eightfold to $10,000 per ounce?
If you think 8X returns are outrageous you forget that in two of the last five decades gold has done exactly that. Gold rose in price from $100-$800 (1973-1980), and then from $250 -$1925 from (2000-2011). With debt and deficits heading this direction long-term investors may want to consider trading in dollars for gold now while gold is cheap. One of the most interesting statistics about the price of gold is that virtually every year the cost of servicing debt has grown, the price of gold has gone higher. The years the cost to service debt went lower, the price of gold went lower.
Many gold bugs will point to the extreme level of total debt as the reason why the price of gold should be higher. These folks are on to something but they may be examining the wrong determining factor when it comes to price. In fact, from 2012-2015 our national debt rose from $14 trillion to over $16 trillion and yet the price of gold dropped more than 30%. The level of debt is not important. The experts that say deficits don’t matter have pointed to the past several years as our debt has surged higher and yet gold has barely moved as the dollar has maintained its strength. Those “experts” have been right until now, but that season has ended.
From here, due to the massive escalation we are facing in debt service pricing, the best case for the U.S. dollar is a lot of losing seasons to come. Worst case, the dollar loses so much value in the coming years that the rules of the global monetary system will need to be rewritten. While fans everywhere hope their football team’s fortunes are headed for a winning season, anyone reviewing the U.S Budget and the cost to service debt while projecting the future value of the U.S. dollar will easily see just one thing, the coming decade doesn’t look pretty.
Adam Baratta is the author of the national best selling book "Gold Is A Better Way." He is one of the leading voices in the field of investments and precious metals today. Adam is the co-owner of Advantage Gold, the highest rated precious metal firms in the country, and the creator of the educational member site, www.goldisabetterway.com.
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