CHISWICK, WEST LONDON – Greetings from my childhood home…
And welcome back to another Postcards mailbag edition, where, every Friday, I answer the latest questions you’ve sent in.
This week, readers imagine a future where the government hikes taxes on gold, big time… I dispel a common misconception about gold as an inflation hedge… and we look at the trouble brewing, once again, in what I call the “plumbing” beneath the world’s financial system…
All this and more below, so let’s get to it…
Reader question: It has been a while since you’ve talked about problems in the plumbing underneath the financial system, but curious if you saw the recent article in The Wall Street Journal about it? Would love to hear your comment on it.
Is it the same sort of problem that you highlighted in the past? In my layman’s understanding, it just smacks of the giant house of cards built by our financial captors. Capitalism is supposed to be simple; this isn’t capitalism.
The Wall Street Journal is talking about the Federal Reserve’s reverse repo facility, and how it’s quickly mushroomed from essentially nothing to almost a trillion dollars since March 1. (The latest reading was $860 billion.)
Repo is short for “repurchase agreement.” It’s a special type of loan that banks make with each other. The Federal Reserve sometimes uses them too, to add or subtract liquidity from the banking system. I started writing about the trouble in the repo market – what I call the plumbing beneath the financial system – in 2019. (Catch up here.)
So what is it, and why does it matter?
The Fed’s reverse repo facility allows the Federal Reserve to borrow money from the banks and money market funds. Why would the Fed borrow almost a trillion dollars from the banks, when the Fed has its own printing press?
Because there’s too much liquidity in the banking system (as a result of the Fed’s quantitative easing). If the Fed doesn’t intervene and borrow this money, this excess liquidity would send interest rates negative, which the Fed doesn’t want. So the Fed becomes the borrower of last resort to keep interest rates from falling.
(It’s funny. The repo meltdown in 2019 was the exact opposite problem. In that crisis, the Fed had to become the lender of last resort to stop interest rates from exploding higher.)
In essence, you can think of the Fed’s reverse repo facility as a sponge for soaking up excess bank reserves in the banking system in order to stop interest rates going negative.
Now, four months ago, there wasn’t any balance. Today, it’s at $860 billion. Why has it mushroomed suddenly?
I’m not certain, but my guess is that it’s because the “SLR exemption” expired in March. The SLR exemption was a sort of grace period that let bankers ignore certain banking rules that had come into existence after the financial crisis.
The Fed gave bankers this SLR exemption in March 2020 as part of its COVID-19 stimulus efforts, when it appeared the financial system might collapse. As soon as it expired in March 2021, the reverse repo facility started mushrooming…
It could just be a coincidence… or maybe it’s just a new “legit” way for bankers to avoid those banking rules for a bit longer and continue to help the Fed print money. We’ll just have to see.
Reader comment: I understand about negative interest rates and how they can reduce the federal debt over time. But when the U.S. is adding more than 5% per year to its debt, the debt will continue to rise, even with negative rates. And I don’t think they can get the rates far enough into negative territory to actually reduce the real debt unless they are also able to sharply curtail spending. And I REALLY don’t see that happening.
To catch new readers up… I’ve written about how the Fed might try to “rescue” the dollar by pushing interest rates into deeply negative territory.
Now, to answer your question, I agree they won’t slow down the government’s spending. They can’t. They’ve made too many promises.
But if they can get inflation up to 10% a year, while only reporting inflation at, say, 2% a year, it’ll seem like GDP is growing at 8%, all else being equal. That will quickly bring down the debt-to-GDP ratio.
So this is now going to be the prime directive of the Fed, in my view: To increase inflation without anyone noticing. Not an easy task…
Reader question: I’ve been a member for some time now. I agree with your analysis regarding the zombie trade. When will you share with the members your trades?
Good question. First, to catch new readers up, I’ve been considering what I call a new “Hero Trade.” That is, betting against the decline of the credit bubble by shorting corporate debt – and junk bonds in particular.
I’m still not certain I want to make this trade, for reasons I explained at the end of Wednesday’s Postcard… and I’d never suggest you do something with your money that I wouldn’t do with my own money.
But I am researching various equities and bonds and will write a report on my findings regardless of its conclusion. As a subscriber of my elite advisory, Tom’s Portfolio, you’ll be the first to find out when I do.
Reader comment: In your June 30 letter, a reader suggested burying your gold “deeper” to avoid metal detectors. I have had thoughts about that myself. One practical answer would be to put the gold in sealed, large-diameter plastic tubes, such as used for waste disposal plumbing, about 12 inches in diameter.
Then, drill one or more deep holes using a post-hole digger and lower it in vertically. Then, fill with about 2 feet of soil, and on top of that, leave some old rusty farm machinery about 12 inches deep and allow a bit of it to protrude just an inch or so above the ground. Most folks would just dig out the junk machinery and throw it back in the hole and go on.
I love this idea. I’ve put a lot of thought into the best ways of burying gold and this is helpful. I worry that drone technology will make it easier for thieves to spot buried gold, and this would be a good solution.
Reader question: I agree that the government won’t confiscate gold, but I do worry about taxes. I suspect that if we were to get some serious inflation, and gold went up to $10,000+ per ounce, Congress might well slap a 90% windfall profits tax on whatever gains we have (in nominal dollar terms).
The resentment of the unprepared against the prepared can be vicious. Why do I fear this? From the government’s point of view, it would be far easier than confiscating gold, and requires no prior planning. And stirring up public opinion in favor of such a tax would be a breeze under those circumstances.
Any ideas about how to defend ourselves against such a move? I have a couple of ideas, but nothing that is likely to work for gold-owners in general.
Yep, it’s possible. I don’t think there’d be any legal way to avoid such a tax. So let’s just hope your fears don’t come true. This isn’t a reason to not own gold, though, especially in physical form.
Reader question: I have a large proportion of my savings invested in gold and silver coins, as a hedge against inflation. My question is: When inflation increases and the value of the dollar continues to decrease, how do we benefit by exchanging gold or silver for those devalued dollars?
I don’t see how I could use my one-ounce gold coins to buy food. If I exchange it for dollars, those dollars are going to lose much of their value before I can spend it all on groceries.
First of all, gold and silver are not a hedge against inflation. They are a hedge against chaos and discord, which, of course, inflation helps create. I don’t mean to be a stickler, but it’s an important distinction.
Second, I do not expect inflation to be so high that the dollar depreciates meaningfully in the time it takes to sell a gold coin at the coin store and spend the proceeds in the grocery store. You’re describing a hyperinflation. I may be bearish on the dollar… but I’m not that bearish.
Another way of saying this is, I don’t expect to have any trouble trading our gold in for dollars again in the future, and then using those dollars to buy whatever we want to buy.
Reader question: This past Friday, you again gave your reasons why you felt the government would not consider confiscating gold. Your take on the government’s money-printing seems to focus on inflating away the national debt. So if “the ambitions of the state” is wealth confiscation through inflation (and I think it is), then owning gold may, in fact, be a threat to those ambitions.
Honestly, I don’t believe our government is above anything these days. While I agree with all your reasons for owning gold, I believe if the numbers get big enough and it’s worth their effort, there will be an attempt at confiscation in some form.
What you’re saying is, the more successful gold is as a wealth protector, the greater will be the risk of confiscation, regulation, taxation or even just scrutiny?
You’re right. The enormous profits the container shipping companies are making at the moment is a good example. It’s attracting the attention of regulators.
But what choice do we have? I’m not going to reject gold because of this fear. Maybe we take it overseas? I’m not sure that’ll help…
Reader comment: I have followed your Postcards since the beginning and love reading them. I just want to make a recommendation for your mother’s house. I think you should definitely buy it. It will give you a stable home base to continue to travel from when you want. Have your brother manage renting it out on VRBO or Airbnb, etc. while you are away. Lock in a long-term loan at the current low rate. Keep your money in gold and let the rent cover your payments.
The biggest issue with my mother’s house (and our desire to buy it) is its opportunity cost.
London is among the most expensive real estate in the world and Mum’s house is in one of the most expensive neighborhoods in London.
It’s true, we love it here. It’s also true that I’m attached to it for sentimental reasons.
But the fact is, we could sell this house and buy a beautiful “home base” in Panama, Costa Rica, or Nicaragua for one-tenth of the proceeds… and then, we could invest the remaining funds in a business, or vacation rentals, or shipping and gold stocks and comfortably live off the income.
My family and I are PERFECTLY prepared for an ex-pat lifestyle like this.
On top of all this, I happen to think London has been a big beneficiary of the global credit bubble. And, as you know if you read these Postcards regularly, I believe the global credit bubble is going to deflate in the coming decade…
Reader question: How are you going to feel when your wonderful parenting is discounted by the state saying you don’t know best – and experimentally vaccinating your children against a disease which has zero morbidity for them and will only cause them potential harm? Just curious.
This is not something I’m afraid of anywhere.
Reader comment: It does not have to be school but you should get your kids into a group (or three groups) where they have the possibility to make friends. They may luck up and make a long-term (or lifetime) friend. When you add more people to your life, it becomes richer, even if the connection is very short or very long. I found that in college, living in the dorm was a much richer experience than living off-campus at home or in an apartment by myself.
We’re trying really hard to introduce our kids to other kids, so that they may make friends.
Kate attends homeschool meet-ups. And I take the kids to sporting clubs, where they can play sports with other kids.
We’re also trying hard to get to know the other families who live in our street. It’s not easy…
Reader question: I love how you and your wife are homeschooling your children. Have you heard of the Tuttle Twins books? They teach children about the free market, freedom, and critical thinking for grammar-school-age children, and chapter books for junior high/high school children, ranging from true heroes in history, inspiring entrepreneurs, logical fallacies, books on choosing your consequence. The author, Connor Boyack, is also working on U.S. history books. Check out their website.
We own the whole set. They’re great, although our boys are too old for them now. They’re most appropriate for children younger than 10 years old, in my opinion.
We’ve moved onto the Uncle Eric series of books by Richard Maybury, although we’re finding our boys are not old enough to understand them yet (they’re 11 and 13).
Reader comment: I have been reading your Postcards for many months now and want to recommend a book I have been reading. The title is How People Learn: Designing Education and Training That Works to Improve Performance by Nick Shackleton-Jones. I think you will enjoy reading it, and perhaps you can use some of the ideas in it as you help your children learn useful skills for life.
Thanks. I’ll check it out.
I always check out the book recommendations readers send us… and often act on them. Please keep ‘em coming at [email protected], along with your questions and comments.
I’ll respond to as many notes as I can in future Friday mailbag editions. (I’ll never reveal your name or potentially identifying details if I republish your note.)
– Tom Dyson