The Federal Reserve Is Going to Be the Government’s Financier

DRIGGS, IDAHO – It feels like we’re approaching a regime change… a once-in-a-generation inflection point… a new era.

It may not happen tomorrow… or next year… but it’s starting…

I’m talking about inflation. More below…

Fresh Snowfall

Greetings from Driggs…

My family and I are a nomadic family. We’re homeless. We live in hotels and Airbnbs.

We’re currently hunkering down for the winter in one of the snowiest places in North America, the western slope of the Teton mountains…

It snowed seven inches overnight, so Dusty (13) and I got up early, drove to the Grand Targhee ski resort at dawn, and stood at the front of the line to ride the chairlift up the mountain.

This is Dusty laying down the first tracks through the fresh snowfall…

Back to London

My mother died on Christmas Eve.

In a few weeks, we must leave Driggs, drive across the United States (for the fifth time in three years), and fly to London to tidy up her affairs, organize her possessions, and sell her property. I’m expecting this to take two months.

I’m dreading this trip. It’s going to be one of the saddest things I’ve ever had to do.

But after that, where will we go?

We have no idea. We need to find a country that’s safe, has a cheap currency, and allows foreigners to enter freely…

Inflation Scares and “Taper Tantrums”

Meanwhile, I spend nearly all my waking hours studying economics (except when we go skiing).

As regular Postcards readers know, my core thesis is simple…

The U.S. government is going to continue running massive deficits and issuing gargantuan quantities of debt (even more than they’ve already been issuing).

There aren’t enough people to buy this debt at the current interest rate.

But, as I wrote on Monday, interest rates cannot rise because the U.S. economy is highly leveraged. It would collapse under higher interest rates.

There’s only one solution. The Federal Reserve must buy the surplus debt and be the government’s financier of last resort. I expect we’ll see the Fed’s balance sheet hyperinflating soon…

For some context, the total size of the U.S. credit markets is roughly $390 billion, going by data from the Securities Industry and Financial Markets Association.

Meanwhile, there’s about $90 trillion in total global stock market value and $281 trillion in real estate, according to my friend and investment strategist extraordinaire Chris Weber.

If interest rates start rising, the Fed may be forced to buy up assets to bail out private borrowers that can’t tolerate higher rates. It wouldn’t take much of a crisis to see several trillions transferred from private markets to the Fed’s balance sheet.

When the pandemic hit, the balance sheet was around $4 trillion. Now, just a year later, it’s near $8 trillion. As I’ve written before in these Postcards, it could easily pass $10 trillion soon… then $15 trillion… then $25 trillion… and keep going…

This will lead investors to start questioning the solvency of the Treasury and the integrity of the U.S. dollar. We’ll see a good ol’ fashioned inflation, debt crisis, and devaluation, as has happened many times in history…

This may take a decade or more to unfold, in which time we’ll lurch from inflation scares to “taper tantrums” with increasing regularity.

(“Taper tantrum” refers to a reactionary panic in the markets that triggered a spike in U.S. Treasury yields in 2013. It came after investors found out the Fed was scaling back on its bond-buying – or quantitative easing – (QE) – program.)

As inflation volatility comes back, it’s going to cause utter havoc in the markets. The big trends of the past 40 years – basically stocks and bonds rise together – will probably reverse.

I think people have an idea that “inflation” will be like the ’70s, and if we just invest in hard assets and commodities and act like trend followers, we’ll be fine… and make easy fortunes.

But that’s not how I see it at all.

I doubt even the inflation will be reliable. It’ll show up in spurts and stutters.

Protect Your Wealth With This Three-Part Portfolio

I read the Ruffer Review today and I loved it. (It’s an annual publication from the investment management firm Ruffer. And it’s free to download here.)

Henry Maxey, Ruffer’s chief investment officer, imagines inflation will be “the sort of stop-go driving of a Land Rover going off-road, where the driver is scared both of going too fast and of stalling the vehicle in a muddy ditch.”

If he’s right, we’re heading for an almost impossible situation for investors… where nothing works.

I can’t imagine the carnage this will cause. And I spend all my time worrying about it.

The correct strategy, I believe, is a portfolio approach with three segments… cash, precious metals, and leveraged inflation bets.

(Shipping is my favorite leveraged inflation bet. Shipping companies have borrowed billions of dollars from the junk bond market… they’re made of steel… and they transport commodities.)

The trick will be to adjust these three allocations depending on the stage of the inflation we’re in.

For example, right now, we’re in an inflationary stage. So I’m recommending a portfolio of 65% gold, 20% silver, and 15% steel.

For the “steel” part of our portfolio, we’ve got a shipping trade on. (I’ve outlined the shipping thesis at length here and here.)

For the next deflationary shock, we won’t want ships in our portfolio. We’ll also want less silver, but we’ll want more cash than usual.

And for the currency crisis, we’ll want less cash and to dial up our holdings of physical gold and silver.

The late Richard Russell, one of the great newsletter writers of the past 50 years, used to boil his investment strategy down to four words: “cash now, gold later.”

I used to love that idea. But now, I’ve come to think that’s too neat… too simplistic. The reality will probably be much more complicated…

Hopefully, we’ll be able to navigate these treacherous rapids together without too much damage…

– Tom Dyson

P.S. In my Tom’s Portfolio advisory, I built the ideal model portfolio to ride the inflationary stage we’re in… and come out on the other side wealthier. It includes the top 12 names to play the shipping trade… the names of my 11 favorite gold stocks… and the exact percentages I recommend allocating to each category. To learn more, watch this.

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

Readers urge Tom to take care of himself, after he was injured skiing a couple of weeks ago and said he pushes through the pain… while another relates to Tom’s pride as a parent…

Reader comment: I caught that sentence and did a re-read. From what you describe of your injuries, you may think lightly now but you are going to regret it as you age on in years. Injuries that result in pain development as it heals is just a forecast of arthritic pain, which will not go away.

I do admire that you keep your joints active, which does help, but that pain is never going away. Just don’t overdo pushing through the pain. You want live a nice, long, healthy life. Stay healthy. Love reading your postcard stories and the remarks about the current market.

Reader comment: Sorry to hear you twisted your foot and knee. I severely twisted my left foot and knee back in February last year. I ripped up muscle and whatever, and my left calf became very swollen. I now walk with a limp as well. Stairs are a nightmare and so very painful.

If you decide to go to the hospital/doctor/surgeon, keep us informed with what they say. Then I’ll know what’s wrong with my leg, too.

Reader comment: My wife and I have long held that the most satisfying feeling a parent can have is when they see their children begin to show signs that they are maturing in exactly the way they had hoped. None of this comes by accident, mind you. It comes from years of hard work by the parents of teaching, caring for, and loving their children, even when it may be very difficult to do.

My wife and I were asked on multiple occasions by others, who marveled at the maturity of our children as they were growing up, what our secret for child-rearing was. We usually just smiled and looked at each other each time this question was posed to us.

Our answer to those parents who asked was always: “Let your children see you show your love for each other. There is no greater feeling of security in a child’s life than when they know they are in a good place. The other things I mentioned previously will come as a result of your love for each other, and your love for your children.”

But the message given to them is something that you and Kate already know. I have looked at the photos and watched as I read your posts from the road… You and Kate do what two parents who love each other do every day: teach, care for, and love your children. And you do it as a team – together.

So take it from one of two parents who have raised five healthy, happy, and professionally successful children, who now have (and are raising) children of their own in exactly the same way. You are doing it exactly right. Keep up the good work and you will continue to enjoy the dividends of being good and loving parents.

Tom’s note: As always, thanks for writing in! Please keep your comments and questions coming to [email protected], and I’ll do my best to answer them in a future Friday mailbag edition.