MAYO, FLORIDA – Earlier this month, Ken Rogoff proposed the Federal Reserve adopt “deeply negative interest rates.” Maybe -5%.

Who is Ken Rogoff and why is this an important signpost? More below…

Final Stages of the World’s Greatest Financial Experiment

Greetings from the Suwannee River Rendezvous campgrounds…

As we’ve pointed out many times, we are in the final stages of the greatest financial experiment the world has ever seen. A bankrupt government is trying to prop up a collapsing debt bubble using the central bank’s money printer.

Ken Rogoff is a prominent Harvard economist and former chief economist of the International Monetary Fund. He’s authored several controversial publications, including The Curse of Cash, a step-by-step guide to eliminating cash from the economy… and This Time Is Different, a study of government debt crises – and their resolutions – going back 200 years.

Now, he’s calling for deeply negative interest rates in a paper titled, The Case for Deeply Negative Interest Rates.

This is interesting because it demonstrates how deeply broken the financial system is. Here’s what I mean…

Only Four Ways Out for the Government

As you know, the U.S. government is deep in debt ($25 trillion and counting). Now, there are several ways a government typically reduces its debt burden.

First, by “growing its way out.” If the economy grows faster than the debt pile, over time, the debt becomes less of a burden. The U.S. “grew its way out” of its heavy World War II debt with strong economic growth through the late ’40s, ’50s, and early ’60s.

Second, by “inflating away the debt.” Inflation erodes the debt burden because the government gets to repay its debts in watered down dollars that aren’t as valuable as the dollars it borrowed in the first place. It’s effectively a default on the debt, but a very subtle one. The inflation of the ’70s is an example. It reduced the government’s debt burden after it borrowed heavily to finance the Vietnam War.

A third way a government can reduce its debt burden is through austerity. In other words, by raising taxes and cutting government spending.

This is unpopular politically, so in the government’s current situation, a combination of option one (growing its way out) and option two (inflating the debt away) would be ideal. Then, they can let compounding do its work for 20 years and the problem will be solved.

But unfortunately for the U.S. Treasury right now, there is no inflation and there is no economic growth. 

The fourth and only remaining way out is default. That’s when the government simply says, “We cannot pay.”

Rogoff’s suggestion is a subtle variant of this last option. Deeply negative interest rates – say of -5% – are a form of default on 5% of the government debt each year. The problem is, while mathematically, deeply negative interest rates would reduce the debt burden each year… no one knows what the unintended consequences would be for the dollar if we had a negative interest rate.

But here’s what I think…

That a prominent Harvard economist is calling for deeply negative interest rates implies the system must be thoroughly broken. I don’t want any part of it.

So here we sit, on the sidelines in gold, waiting to see which of the various methods above the government chooses to reduce its debt burden…and disappoint its creditors.

– Tom Dyson

P.S. As you know, Kate and I went “all in” on gold nearly two years ago, as a way to keep our wealth safe while we wait for the Dow-to-Gold ratio to fall. In fact, I invested nearly $1 million of my own money into this strategy. But there’s more to it than just buying bullion…

On Wednesday, May 20, I’m sharing the details of my strategy in a special briefing. Save your spot right here.

Like what you’re reading? Send your thoughts to [email protected].

FROM THE MAILBAG

Readers ask about the validity of bitcoin… and Tom’s Dow-to-Gold timeline…

Reader comment: If, as Tom writes of bitcoin, “THIS IS IT,” what makes it not so any longer? I actually learned of it a bit earlier than Tom and in a similar way, but was turned off by the process needed to convert dollars into bitcoin. I thought it was a scam. My relatively modest investment when bitcoin was in the neighborhood of $1 would have been worth millions today.

I watched it run up and crash over the years (as well as get stolen), but finally picked some up with the arrival of Coinbase. They not only made it conventionally available (and not a technogeek exercise in frustration), but also guaranteed accounts. It was the PayPal of crypto. Although I hold physical gold in storage as well, the benefits and liquidity of bitcoin seem like a prudent digital gold holding. I’ve apportioned about 10% of my gold holdings to it. Doesn’t Tom hold any crypto?

Tom’s response: I do not own any bitcoin. When I found it, I knew it would be popular and it was unique. But now, the price is 2000 times higher and there are hundreds of other cryptos all competing for the world’s savings. Each new crypto is – as I see it – a form of inflation. New crypto supply is unlimited.

I can’t see why bitcoin has any value. It doesn’t even function very well. It certainly doesn’t compare to gold. Besides the fact that bitcoin experienced a “tulip mania” in 2017. I’ve never seen an asset come back after going through a “tulip mania” without going through a long period of stagnation first. Gold is a far better bet, in my opinion.

Reader comment: So glad you are off on your journey again! Everyone looks so relaxed and happy in the photos! Thank you for your thoughts about the Dow-to-Gold ratio. Could you expand a bit on your five years’ expectation/hope? Is this some “cycle” or other that leads you to that particular timetable? I’ve seen you state the five years before!

Tom’s response: I don’t know how long this cycle will take to play out. No one does. But I’ve mentally prepared for it to take five to 10 years. Things seem to be moving much quicker than that, but I don’t want feel frustration when the trade doesn’t get there immediately. I’m hoping it happens sooner… but I’m preparing for it to take a while.

While another reader thanks Tom for his clarity on tanker stocks… Here was Tom’s response:

Everything I wrote about oil tankers is still accurate. In fact the case has only gotten stronger. They reported earnings last week, and I can tell you they are earning fortunes. It seems they’ll continue earning fortunes, and the stocks have gotten even cheaper. This is the first time in my life I’ve ever seen high quality businesses, making record profits, with great forward fundamentals, trading at P/E ratios less than 3. This is definitely a case of the stock market being irrational. I remain unequivocally bullish on tanker stocks.

Tankers are a “feast or famine” business. The last 12 years have been “famine.” My hypothesis is, we’re now entering a two-to-three year period of “feast.” The last three quarters have been excellent. I think there’s two or three more years of this to come. Tanker stock investors have been so traumatized by 12 years of losses and red ink, they can’t see it. But those in the know are calling this the beginning of a tanker “super cycle.”

I think the tanker companies are going to earn more than enough money in these super cycle years to make up for all their sins over that past 12. (And I should note that the super cycle idea has nothing to do with coronavirus and everything to do with industry fundamentals.)

I’m not surprised by the irrationality. Share prices often behave like this (volatile, choppy trading) at important turning points. The bulls and bears are duking it out…

What I failed to anticipate was quite how volatile their stock prices would be. They trade like options, bouncing around 10% or more on a daily basis. I didn’t foresee that. Had I known they’d be this volatile, I’d have added a warning early on to my bullish opinion. That said, despite the volatility, tanker stocks do have two benefits that options don’t have: They pay you enormous dividends to hold them, and there’s no time decay.

If it’s any consolation, a 25% drop is par for the course in tanker land. And I, too, am down about 25% in my personal tanker stock positions. But I’m not selling. I’ve done my research and I’m comfortable with my position size. I know it’s just a matter of time until the share prices turn around.

And, as always your messages are an integral part of these Postcards. Please keep writing us at [email protected]