Principles as follows:
When national debt is excessive, lowering interest rates and devaluing the currency in which debt is denominated is the most likely priority path for government policymakers, so betting on this scenario is worthwhile.
At the time of writing, we know that significant deficits and government debt, along with debt servicing expenditures, are expected in the future. (You can find these data in my works, including my new book 'How Nations Go Bankrupt: The Big Cycle'; I also shared last week why I believe the US political system cannot control the debt issue). We know that debt servicing costs (paying interest and principal) will grow rapidly, squeezing out other expenditures, and we also know that the likelihood of debt demand increases matching the debt supply that needs to be sold is extremely low at best. I elaborated on what I believe this all means in 'How Nations Go Bankrupt' and described the mechanisms behind my thinking. Others have also stress-tested this, and currently almost completely agree that the picture I've drawn is accurate. Of course, this doesn't mean I cannot be wrong. You need to judge for yourself what might be true. I'm just providing my thoughts for everyone to assess.
My Principles
As I explained, based on my investment and research experience over the past 50+ years, I developed and documented some principles to help me predict events and successfully bet on them. I'm now at a stage in life where I want to pass these principles on to others to provide help. Moreover, I believe understanding how mechanisms work is crucial to comprehending what is happening and what might happen, so I also try to explain my understanding of the mechanisms behind these principles. Here are several additional principles and explanations of how I believe the mechanisms work. I believe the following principles are correct and beneficial:
The most discreet, and therefore most preferred and common method for government policymakers to address debt oversupply is to lower real interest rates and real exchange rates.
While lowering interest rates and currency exchange rates to address excessive debt and its problems can provide short-term relief, it reduces demand for currency and debt, and creates long-term problems by lowering the returns on holding currency/debt, thus reducing the value of debt as a wealth store. Over time, this typically leads to increased debt, as lower real interest rates are stimulative and worsen the problem.
In summary, when debt is excessive, interest rates and currency exchange rates tend to be pushed down.
Is this good or bad for economic conditions?
It's both. In the short term, it's often good and widely popular, but in the long term, it's harmful and leads to more severe problems. Lowering real interest rates and real currency exchange rates is... beneficial in the short term because it's stimulative and tends to push asset prices up... but harmful in the medium and long term because: a) it provides lower real returns for asset holders (due to currency depreciation and lower yields), b) it leads to higher inflation rates, c) it leads to greater debt.
In any case, this clearly cannot avoid the painful consequences of overspending and being deeply mired in debt. Here's how it works:
When interest rates fall, borrowers (debtors) benefit because this reduces debt servicing costs, making borrowing and purchasing cheaper, thus pushing up investment asset prices and stimulating growth. This is why almost everyone is satisfied with lower interest rates in the short term.
But simultaneously, these price increases mask the adverse consequences of lowering interest rates to undesirable low levels, which is detrimental to lenders and creditors. These are facts because lowering interest rates (especially real rates), including central banks suppressing bond yields, drives up bond and most other asset prices, thereby reducing future returns (for example, when rates turn negative, bond prices rise). This also leads to more debt, causing larger debt problems in the future. Thus, the returns on debt assets held by lenders/creditors decrease, creating more debt.
Lower real interest rates also tend to reduce the real value of currency because they make currency/credit yields relatively lower compared to alternatives in other countries. Let me explain why lowering currency exchange rates is the preferred and most common way for government policymakers to handle debt oversupply.
Lower currency exchange rates are favored by government policymakers and seem advantageous when explaining to voters for two reasons:
1) Lower currency exchange rates make domestic goods and services cheaper relative to goods and services from countries with appreciating currencies, thus stimulating economic activity and driving asset prices up (especially in nominal terms), and...
2) ...it makes debt repayment easier, which is more painful for foreign debt asset holders than domestic citizens. This is because the alternative "hard currency" approach would require tightening monetary and credit policies, leading to persistently high real interest rates, which would suppress spending, typically meaning painful service cuts and/or tax increases, and stricter loan conditions that citizens are unwilling to accept. In contrast, as I will explain below, lower currency rates are a "hidden" way of repaying debt because most people are unaware that their wealth is diminishing.
From the perspective of a depreciating currency, lower currency exchange rates also typically increase the value of foreign assets.
For example, if the US dollar depreciates by 20%, US investors can pay foreign holders of dollar-denominated debt with a currency that has lost 20% in value (i.e., foreign debt asset holders will suffer a 20% monetary loss). The harm of a weaker currency is less obvious but real: those holding a weaker currency experience reduced purchasing power and borrowing capacity—purchasing power decreases because their currency's buying power diminishes, and borrowing capacity declines because debt asset buyers are unwilling to purchase debt assets or currency denominated in a depreciating currency (i.e., assets promising to receive currency). This is less apparent because most people in countries using the depreciating currency (e.g., US dollar users in the US) won't see their purchasing power and wealth decline because they measure asset values in their own currency, creating an illusion of asset appreciation, even though the currency value of their assets is falling. For instance, if the US dollar drops 20%, US investors focusing only on the rising dollar-denominated value of their assets won't directly see their 20% loss of purchasing power in foreign goods and services. However, for foreign holders of dollar-denominated debt, this would be evident and painful. As they become increasingly concerned, they will sell (offload) the debt-denominated currency and/or debt assets, causing further weakness in the currency and/or debt.
In summary, viewing issues solely from the perspective of one's domestic currency clearly creates a distorted view. For example, if something (like gold) rises 20% when priced in dollars, we would think that item's price has increased, not that the dollar's value has decreased. The fact that most people hold this distorted perspective makes these debt management methods "discreet" and politically more acceptable than other alternatives.
This way of looking at things has changed significantly over the years, especially from when people were accustomed to the gold standard monetary system to now being accustomed to the fiat/paper currency system (i.e., currency no longer backed by gold or any hard assets, which became reality in 1971 when Nixon decoupled the dollar from gold). When currency existed as paper and was a claim on gold (what we called gold standard currency), people believed the paper's value would rise or fall. Its value almost always fell, with the only question being whether it fell faster than the interest rate obtained from holding fiat currency debt instruments. Now, the world has become accustomed to viewing prices through a fiat/paper lens, and they have the opposite perspective—they believe prices are rising, not that currency value is declining.
Because a) prices denominated in gold-backed currency and b) the quantity of gold-backed currency have historically been much more stable than a) prices denominated in fiat/paper currency; b) the quantity of fiat/paper currency, I believe that viewing prices from the perspective of gold-backed currency may be a more accurate approach. Evidently, central banks share a similar view, as gold has become their second-largest currency (reserve asset), second only to the US dollar and ahead of the euro and yen, partly for these reasons and partly because the risk of gold being confiscated is lower.
The extent of decline in fiat currency and real interest rates, and the rise of non-fiat currencies (such as gold, Bitcoin, silver), has historically (and logically should) depend on their relative supply and demand. For example, massive debt unsupported by hard currency can lead to significant monetary and credit expansion, resulting in a substantial drop in real interest rates and real currency exchange rates. The most significant period when this occurred was the stagflation period from 1971 to 1981, which led to massive changes in wealth, financial markets, economic, and political environments. Based on the scale of existing debt and deficits (not just in the US, but in other fiat currency countries), similar massive changes may occur in the coming years.
Regardless of whether this statement is correct, the severity of debt and budget issues seems undeniable. During such periods, holding hard currency is beneficial. To date, and for many centuries worldwide, gold has been hard currency. Recently, some cryptocurrencies have also been viewed as hard currency. For certain reasons I won't elaborate on, I prefer gold, although I do hold some cryptocurrencies.
How Much Gold Should One Hold?
While I'm not providing specific investment advice, I'll share some principles that have helped me form my perspective on this question. When considering the proportion of gold to bonds, I think about their relative supply and demand, as well as the relative costs and returns of holding them. For example, currently, US Treasury bond rates are around 4.5%, while gold's rate is 0%. If one believes gold prices will rise more than 4.5% in the next year, holding gold is logical; if not, holding gold is unreasonable. To help make this assessment, I observe the supply and demand of both.
I also know that gold and bonds can diversify risk, so I consider how much of each to hold for good risk control. I know that holding about 15% gold can effectively diversify risk, as it can bring a better return/risk ratio to the portfolio. Inflation-linked bonds have a similar effect, so it's worth considering adding both assets to a typical portfolio.
I share this perspective with you, not to tell you how I think markets will change or recommend how many assets you should hold, because my goal is to "teach a man to fish, not give him a fish".
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