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U.S. Government Bonds - Can America Maintain Confidence in its Debt?

Massive, unsustainable government debt - it's everywhere. Especially in America. At some point, will the world begin to lose confidence in America's growing debt? Will interest rates then skyrocket? Will a Greek-style crisis in U.S. Government bonds then ensue? Is there any way out?

America can claim its debt problems are not as bad as some countries. But that ignores some important points:

1. See an interesting chart on how America's financial condition is worse than several other countries.
2. Even the most respected bond manager in the world, Pimco's Bill Gross, believes there are several countries including the U.S. whose financial ratios are in dangerous territory - the "ring of fire".
3. A loss of confidence in the U.S. dollar and U.S. debt could bring a "Greek-style" crisis to the whole world. Consider that the U.S. dollar has been the world's reserve currency since 1945; it has been accumulated by the whole world as a form of trusted and secure savings. There are trillions of dollars of U.S. government debt accumulated as reserve savings by banks around the world (see chart below courtesy of Hugo Salinas Price) and realize that most reserves are held as U.S. Government bonds. A loss of confidence in the U.S. dollar and in the ability of the U.S. to service its growing debt could trigger an epic disaster.

Paper Reserves in Central Banks

Is there any way for America to maintain the confidence?

One way would be for America to become fiscally prudent, simply stop creating money and debt, let the massive deflationary forces of credit contraction and consumer de-leveraging run their natural course. This would cleanse the system of toxic debt. It would also clearly and immediately cause another Great Depression.

Another way would be for America to simply print more money, create more debt, blindly following Keynesian economics that brought us into this mess in the first place. Attempt to "inflate away" the debt without losing the confidence of investors that buy the U.S. Government bonds. This has been tried many times throughout history with disastrous consequences. The chart below (courtesy of Economic Edge) shows how increases in debt are recently giving less and less "umph" to economic GDP growth to the point now of negative GDP growth. Eric Sprott has produced an excellent study suggesting that 9 cents of "growth" is coming with every dollar we go deeper into debt. Bud Conrad has produced calculations that are equally discouraging. This massive debt-driven money printing would therefore likely lead some form of hyperinflation in a futile attempt to stimulate economic growth.

Diminishing Marginal Productivity of Debt in the US Economy

This leaves one other option.... a direction that is hardly ever considered... a policy tool still waiting to be tried!... America could return to the gold standard... Why? Because the gold standard system would back the U.S. Dollar by real money, and enforce a responsible discipline of fiscal and monetary policy that Congress and the Federal Reserve cannot currently do. In turn this would maintain confidence in America's debt.

Ludwig von Mises

"The gold standard has one tremendous virtue: the quantity of the money supply, under the gold standard, is independent of the policies of governments and political parties. This is its advantage. It is a form of protection against spendthrift governments." Ludwig von Mises (1881-1973)

Monetary systems on a gold standard system cannot increase money supply as needed. Under a gold standard system, paper money is backed by something of real tangible value. The total amount of gold limits the total amount of paper money that can be created. New money must be backed by additional gold. Omnis' Jim Rickards suggests this possible solution: a "gold backed currency at a non-deflationary price... sound money leads to sound growth and the creation of real, not illusory, wealth."

"Tricky Dicky" Nixon

In 1971, President Nixon simply severed the tie between gold and U.S. Dollars. As he closed the gold "window," Nixon proclaimed "We are all Keynesians now" (referring to the Keynesian economic school of thought where gold has no function). Austrian School economists and Cliff Küle would like to say - We are not all Keynesians.

Did severing the link between the dollar and gold work to strengthen confidence in the U.S.? Please consider: 1) within a generation of that move, the U.S. went from being the world's largest creditor nation to the world's largest debtor. 2) TIME magazine of 1979 said "until the greenback is once again made as good as gold, many millions of people will persist in believing that the barbarous relic is still a better bet."

Slick Willy

Recently speaking about Goldman Sachs' problems at the Peter G. Peterson Foundation, former President Bill Clinton said, "There is a bigger problem here... too much of our growth was in finance ever since went off the gold standard."

The dollar "tie" to gold might be "re-tied" just as simply as it was untied. In a certain respect, America never really went off the gold standard. The tie between gold and U.S. dollar was simply adjusted to 0%. So, simply adjust it back. What tie would be needed today to restore America back to the gold standard? Let's do the simple math.

Official figures for the total amount of gold reserves held by the U.S. Treasury are 8133.5 tonnes of gold. This gold is owned by all Americans and is held in trust by the government for the people. Given that 1 metric tonne is 32150.746 ounces, that amounts to:

8133.5 tonnes x 32150.746 ounces/tonne = 261498092.591 ounces

If we look at recent Federal Reserve data, we note that the total U.S. M1 seasonally adjusted money supply is at $1712.2 Billion of currency. Therefore if we were to take the total currency and back it by the total amount of gold, this would give:

$1712.2 Billion divided by 261498092.591 =
US$6547 per ounce

There you have it - if the U.S. were to devalue the U.S. Dollar, setting gold at 6550 U.S. Dollars per ounce of gold, the country could position to go back on the gold standard. Global confidence in the U.S. dollar and in America's debt would be maintained. It may be as simple as finding the right price for the government gold holdings to give "backing" to every dollar in circulation.

$6550/ounce is approximately the current value necessary to give "gold backing" to the current level of M1 money supply. If the U.S. wanted to expand the money supply further to stimulate the economy, it would need to set a new price for its gold holdings which is even higher than $6550/ounce or somehow get more gold. The U.S. could then be in a position to expand money supply as necessary to stimulate growth and able to extend credit to other nations. This is an essential ingredient to restoring confidence and keeping the title of reserve currency. After all, a reserve currency should be able to extend credit to nations in need, not be in need of credit from other nations.

As Jim Rickards states, this one-to-one ratio backing of gold with the U.S. Dollar "would comfortably support a broader U.S. money supply on a one-to-one ratio and maintain confidence in the dollar and U.S. sovereign debt." Perhaps only then could global confidence in the U.S. Dollar and in U.S. debt be maintained - if not, either a deflationary depression or a hyperinflationary depression could be in store as confidence wanes with increasing levels of public debt.

Back to the Future

Nick Barisheff, President and CEO of Bullion Management Group, emphasizes gold is money: "Gold is not and never has been a currency. Gold is something entirely different and far more valuable. It is money." Cliff Küle suggests that to maintain confidence in its debt, America must bring back the gold standard, anchoring the U.S. dollar back to real money - gold, as Article 1 of the Constitution of the United States commits it to be.


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