 Real
Rates and Gold 6
Adam Hamilton
Archives
January 31, 2004
One of the most important fundamental
drivers behind the current fabulous golden bull in US dollar
terms is the surreal negative-real-interest-rate environment
that now plagues Americans courtesy of the Federal Reserve.
Negative real rates are relatively
rare in financial history, as they represent an inherently unstable
and artificial state created by central bankers attempting to
try and seduce their countrymen and corporations into piling
on ever increasing amounts of debt.
The central bankers hope that
the rocketing debt growth spawned by negative real rates will
ultimately translate into economic growth as the fiat cash injected
into the system by spiraling fractional-reserve debt creation
soars. They hope this debt-injected cash will precipitate an
economic boom.
Negative real rates create
enormous problems though, as they effectively steal from hard-working
savers to subsidize wastrel debtors. In normal markets both savers
and debtors are offered fair prices for capital, for both lending
it and borrowing it. Mutually beneficial transactions for both
parties are possible, and capital-market commerce thrives.
In negative-real-rate environments,
a central bank artificially manipulates short-term interest rates
so low that they are actually driven below the official rate
of inflation. This means that savers and investors actually lose
real purchasing power by lending and investing their capital.
$100 that they lend this year might return as $101 in nominal
terms next year, but this $101 can really only purchase the equivalent
of $99 worth of goods today. True purchasing power, and hence
real wealth, is gradually hemorrhaged.
Over time, these negative real
returns decimate the savers and investors in the capital markets.
Debtors, like parasites or vampires, gradually suck the life
out of savers as they are offered unfair and artificial deals
due to brazen central-bank short-rate manipulation. Instead of
savers and debtors being able to enter mutually-beneficial transactions,
win-win situations, savers are forced to only be able to lose
purchasing power while the debtors greedily gobble it up.
Savers are faced with an unpleasant
choice in these environments hostile to wealth creation. Do they
lend their capital to borrowers at a negative real return, fully
realizing that they will lose purchasing power and wealth every
year, or do they just quit lending entirely and try to protect
their capital from central-bank depredation by any possible means?
Sadly in America today, we
are slowly learning the answer to this crucial question. In a
desperate gamble to try and reignite a failed stock-market bubble,
Alan Greenspan and his Fed are remaking a terrible mistake that
has only led to pain and misery throughout history. US real rates
have been bludgeoned relentlessly lower since 2000, and the bitter
fruits of officially plundering savers to subsidize debtors are
slowly becoming apparent.
American savers and investors
are gradually starting to understand the perils from the Federal
Reserve's orchestrated attack on their wealth and are taking
appropriate action to protect the hard-earned fruits of their
labors. Slowly, but relentlessly, more and more are taking refuge
in tangible assets that the Fed cannot devalue or destroy. The
king of these negative-real-rate refuges is the Ancient Metal
of Kings itself, gold.
Way back in July 2001, when
gold was trading under US$270 per ounce and few believed that
a glorious new gold bull was even possible, let alone a high
probability, I penned my original "Real Rates and Gold"
essay. I closed it with, "As the hard-earned capital of
bond investors is wrongfully expropriated through inflation and
negative real interest rates, we fully expect a significant portion
of that capital to make a mass exodus to the rock-solid financial
refuge of gold."
And so it came to pass. Real
rates had not yet plunged negative in the States in July 2001,
but they were hovering perilously close after the infamous Greenspan
Gambit to reignite a failed supercycle equity bubble was launched.
Not long after that they shot negative for the first time in
decades. As expected from hard historical experience, more and
more savers recognized this dire warning signal and fled into
the fortress of gold rather than wait around helplessly while
debtors directly plundered them through immorally low prices
for capital.
Today, as a gold investor and
speculator, I like to update and reexamine our real-interest-rate
and gold charts about once every quarter or two, to keep an eye
on the progression of both the gold bull and the Greenspan War
Against Savers. As we haven't looked at real rates and gold since
September, this week seemed like a great opportunity to update
this absolutely crucial analysis for savers, anyone who has worked
hard enough during their lives to accumulate surplus capital.
We'll begin with the latest
update of our grand strategic chart, which vividly illustrates
just how bullish for gold negative-real-rate environments truly
are.
As you can see during the past
few years of this long-term chart, we are now blessed to be living
through and growing wealthy in the greatest bull market in gold
since the mid-1980s or so! Gold has soared from just over $250
to around $425 since this awesome new bull began, and real rates
have plunged from around 3% down to negative 2% at worst over
this same period of time. Savers are migrating into gold, as
expected.
The Big One, the massive gold
Great Bull and ultimately bubble of the late 1970s, also corresponded
with a similar negative-real-rate environment that was officially
hostile to savers trying to painstakingly accumulate capital.
The first decade of this chart is incredibly eye-catching, as
the entire 1970s were dominated by terribly unfair real rates
penalizing savers and the resulting mass exodus into gold for
capital preservation was breathtaking.
Really anytime in the last
few decades, whenever real interest rates plunged under positive
1% or so for an extended period of time, gold managed to achieve
some incredibly impressive to legendary rallies and bull markets.
The last major gold bull, launching in 1985 or so, corresponded
with a period of time when high real rates were falling like
a rock and savers were feeling the pain.
The early-1990s gold rally
launched when real rates flirted with zero. And of course the
present 2001 gold bull ignited when the US Fed foolishly declared
war on savers to try and salvage a doomed stock-market bubble,
relentlessly driving real rates negative and helping to reawaken
a sleeping gold giant with a great and terrible resolve. Few
general economic factors are more bullish for gold than a negative-real-interest-rate
environment openly hostile to savers!
Gold is a timeless bastion
of financial strength, a rare monetary asset with indisputable
intrinsic worth in and of itself through six millennia of human
history. Unlike paper currencies, which are merely promises to
pay in the future backed by nothing but faith in some fallible
human government, gold is true money. Gold always has been valuable
and always will be valuable, and investors and savers across
the globe instinctively know this.
So, when fiat-paper-currency
saving and investing is threatened by inflation rates above obtainable
nominal interest rates, slowly but surely savers realize that
it is foolish to take a real loss in purchasing power and wealth
every year just because a central bank wants to unfairly subsidize
debtors. Gradually more and more savers decide to withdraw their
capital from the usual capital markets and instead park a growing
portion in gold, where irresponsible governments cannot erode
its purchasing power through inflation and negative real rates.
This is certainly fantastic
news for gold, and indeed investing and speculating in gold on
the long side are probably the best ways to play a negative-real-rate
environment. Sadly though, there are terrible consequences to
artificially upsetting the great balance of capital-market commerce.
The longer that the Fed holds short rates low enough to rob savers
to subsidize debtors, the more that savers will grow discouraged.
As a lifelong saver who has never had any debt I am in the minority
now in lamenting this, but I guarantee that I won't be for long!
As more and more savers become
discouraged like me, gradually the capital markets in the US
will seize up. Private investors and savers will stop buying
Treasury bonds, mortgage-backed bonds, agency securities, and
corporate debt. As bond purchases fall, interest rates will be
forced higher in the free markets. Why should I, or you or anyone,
lend the finite and precious capital that we have worked so hard
over a lifetime to accumulate when we are guaranteed to lose
real purchasing power and wealth just for making our funds available
to debtors?
If the Fed wants to steal from
me to subsidize some goofy debtor, the heck with the Fed and
the conventional capital markets! I can stay well ahead of the
inflationary depredation, and earn legendary profits to boot,
by shifting my capital and resources into precious metals rather
than dismally low-yielding bonds or hyper-overvalued and equally
dismally low-yielding stocks. And this is exactly what I have
done personally and recommended that my clients do as well since
this gold bull stealthily began.
See the terrible problems and
bitter fruits evident here friends? Savers and investors drive
economic growth. But when the Fed forces real rates negative,
they deny us a fair return for our stored labor in the form of
our capital savings. While we are blessed to have the capital
to finance ventures to move the economy forward, what is the
point in even making our capital available if we are guaranteed
to lose purchasing power for putting it at risk? Aren't we supposed
to actually earn money by risking our hard-earned capital?
Negative real rates squeeze
the life out of conventional capital markets, discouraging savers
and investors over time and ultimately retarding economic growth.
And these savers and investors seek a refuge where governments
cannot dictate terms to them, where their hard work and purchasing
power will be preserved until sanity returns to the conventional
capital markets.
So flight capital starts flowing
into the precious metals, slowly at first as today or in the
early 1970s, but ultimately in a great deluge that culminates
in a major gold bubble as in the late 1970s and perhaps again
in the coming decade sometime. When the gold bubble arrives,
saver and investor confidence is so damaged by gross central-bank
mismanagement that real rates have to soar to massively positive
levels to entice savers back into the conventional capital markets,
just as in the early 1980s.
It is so incredibly important
to realize that the low-rate financial tidings that are celebrated
today, like very low mortgage rates, are not one-sided transactions.
Every ultra-low below-long-term-fair-market-value mortgage interest
rate today outright steals from the savers and investors on the
other side of this transaction. This disincentive to lend gradually
dries up the pool of available capital for future investment.
Today's home "owners"
who have 75%+ of "their" houses debt financed may think
that they are getting a steal at nearly 50-year low interest
rates, and they are. On the other side of these transactions
though are savers, including many elderly folks who have busted
their tails and worked hard for over four decades to painstakingly
accumulate a capital surplus to finance their retirements.
These savers make a trivial
nominal return even in a negative-real-rate environment, but
after inflation they can buy less and less with each passing
year. Many have seen their retirement incomes cut by 80% or more
thanks to Greenspan's wholesale robbery of savers. It is sad
and appalling, and history will curse the memory of Alan Greenspan
like it does John Law. Capital markets cannot sustain such a
gross disconnect between savers and debtors indefinitely.
Zooming in, the relationship
between our current gold bull and the Greenspan War Against Savers
is even more readily apparent. The exact same fundamental market
relationships that dominated the 1970s and early 1980s remain
strong to this day. It never ceases to amaze me that the Fed
does not seem to be petrified about repeating the horrible 1970s,
as it has been merrily on this disastrous course since it foolishly
tried to reignite a failed stock bubble in early 2001.
Back in early 2000, even while
the speculative mania in the stock markets soared, the capital
markets were fairly healthy with a positive 3% real rate of return
for savers. With 1y Treasuries yielding a bit over 6% while CPI
inflation ran around 3%, savers could expect to actually increase
their purchasing power year-over-year by lending their precious
capital to debtors, the way that the markets are supposed to
work.
It is quite interesting that
the long bear market in gold continued throughout 2000 as well.
Gold really didn't start stabilizing and carving a major long-term
secular bottom until early 2001, soon after the US Fed began
slashing short-term interest rates like there was no tomorrow
in order to attempt to bailout overextended stock-market speculators.
As the real rates of return finally plunged decisively below
positive 1% at the end of Q1 2001, the gold bull market subtly
launched.
Since then, real rates in the
United States have remained under positive 1% for the most part,
a terrible rate of return for savers. By early 2003 they plunged
as low as negative 2%, the lowest real rate of return witnessed
in America since 1980, over 20 years ago now! As I discussed
in "Real Rates and Gold 5" these real rates have risen
modestly in 2003, primarily due to government lowballing of the
official CPI inflation numbers, but they still remain very negative
and destructive for savers.
With CPI inflation reportedly
running at 2% now, according to the unaccountable bureaucrats
in Washington, in order to restore even a quasi-healthy positive
2% real rate of return again for American savers and investors
we would have to see short-term rates utterly soar. Nominal interest
rates would have to rocket up by a breathtaking 3%, from 1% to
4%, in order to see even low-end positive real returns for savers
again.
To run from 100 basis points
up to 400bp is a massive quadrupling of the cost of money over
the short-term! In other words, to restore a more normal balance
between savers and debtors, making mutually-beneficial capital
transactions possible again, the Fed would have to increase the
costs of borrowing money for short-term debtors by an incredible
4 times!
How likely is this to happen,
at least voluntarily on the cowardly Fed's part, in the coming
years? Not very! By enticing and seducing folks into taking on
far more debt than any sane person should ever even consider,
the Fed has created a giant economic trap. If short rates rise
significantly, overextended debtors will be crushed like bugs,
especially those who have debt without fixed costs such as adjustable-rate
mortgages that rise with general interest rates.
So the Fed has tied its own
hands and is pretty much damned if it does restore saver/debtor
balance and damned if it doesn't. If it finally quits manipulating
short rates artificially low, savers will gradually want to reenter
the capital markets, which will grow healthier over time. But
debtors will be squeezed until their eyeballs are ready to pop
out of their skulls as their already overextended debt burdens
are ratcheted relentlessly higher to excruciating levels by rising
rates. In addition, the hyper-overvalued US stock markets would
plummet if interest rates even doubled, let alone quadrupled!
But if the Fed doesn't restore
saver/debtor balance through fair and mutually beneficial short
rates, then savers will continue to leave the American capital
markets in favor of other less hostile destinations including
the mighty fortress of gold. The US dollar will continue to fall
and the financial markets will grow less and less healthy until
some kind of exogenous crisis shocks the system in the coming
years.
The ultimate reckoning will
be ugly, as it was in the early 1980s for stocks and bonds alike.
Naturally gold will continue spiraling higher in such a hostile
negative-real-rate environment, probably climaxing in a magnificent
speculative mania bubble again sometime in the coming decade
or so.
Now if the Fed had an ounce
of courage amongst its bureaucrats, it would cease plundering
savers to subsidize debtors today. Greenspan would publicly announce
that short rates were going to at least 4%, the terribly overvalued
equity markets would crash, and slowly but surely the gross speculative
excesses of the mania years would work their way out of stocks,
real estate, and other areas of the US economy.
But, realistically, what are
the odds of such a scenario? I suspect zero. The vast majority
of Americans have chosen to be poorer and have a much lower standard
of living in the future by borrowing from future earnings to
service debt today. Since democracies are political creatures,
it is highly unlikely that the Fed would even consider doing
the right thing when the US is so awash in staggering levels
of debt across the board. Odds are the Fed will take the "easy"
path, letting the speculative excesses continue to fester and
grow until the markets force an ugly reckoning.
While this is an admittedly
dim and discouraging scenario, it does have a silver lining.
If the Fed is going to keep real rates artificially negative
for as long as it can in the coming years, then the young Great
Bull in gold and silver will only accelerate. More and more savers
will grow discouraged and they will park their capital in the
precious metals to protect it from debtors eroding and stealing
purchasing power each year via negative real rates.
So as long as real rates in
the US remain negative, one of the most powerful foundational
fundamental underpinnings of this gold bull remains firmly in
place. And as investors we can be pretty sure that this gold
bull will continue accelerating to the upside just as it did
in the 1970s in a similar era hostile to capital accumulation.
Actually, this gold bull will
probably continue galloping higher until real rates shoot massively
positive in the years ahead, similar to the early 1980s, in order
to finally convince savers and investors worldwide that the Greenspan-War-Against-Savers
madness has finally ended!
As such, we will continue to
watch real rates at Zeal, analyzing them periodically. I strongly
encourage all of you hardworking savers who have painstakingly
lived under your incomes for decades in order to accumulate surplus
capital to do the same.
Negative real rates are one
of the most important ingredients for a massive bull market in
gold, and the way things look now they are going to remain negative
in the States for some time to come.
Rather than watching debtors
steal from you, you savers will be much better off taking refuge
in gold and silver. Your wealth and purchasing power will not
only be preserved, but you will probably earn enormous real profits
as this powerful gold bull continues soaring in the years ahead.
Adam Hamilton, CPA
email:
zelotes@zealllc.com
Archives
January 30, 2004
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