“It’s best to have some gold right now,” Greenlight Capital hedge-fund manager David Einhorn advised the audience at the 2022 Sohn Investment Conference last week. “The price will rise higher, perhaps much higher.”
Mr. Einhorn is bullish on gold because he believes the inflation genie will not be going back into its bottle any time soon.
The Fed only began raising its policy rate in March, after inflation in consumer prices had soared to a 40-year high of 8.5 per cent. On Wednesday, it hiked the rate by 0.75 of a percentage point, and plans to continue raising the target rate (now in a range between 1.5 and 1.75 per cent) until it reaches 2.5 to 3 per cent.
In the past, Fed chairs Alan Greenspan, Paul Volcker and Arthur Burns had to push interest rates above inflation and create positive real rates, noted Mr. Einhorn. “In 1980, Volcker raised rates to 19 per cent to combat inflation of 14 per cent and in 1990, Greenspan raised them to 8.5 per cent to fight 6-per-cent inflation. Even Burns in 1974 raised to 13 per cent to fight 11.5-per-cent inflation – although he retreated too soon.”
“Today, we have real interest rates at their most negative [minus 7.5 per cent] in the last 70 years. So, the idea of tightening to 3 per cent is hardly credible.” Not that the Fed could hike much beyond this target anyway: One big problem is historically high levels of debt.
The U.S. public holds over US$24-trillion in debt, up more than sixfold in the past 20 years, Mr. Einhorn said. With so much debt supporting consumption and the economy in general, rate increases suggest bankruptcies will occur sooner and more frequently than in the past for every percentage-point increase in rates. This could compel the Fed to ease up on its inflation battle before it is won.
Rising rates will also be a strain on the government’s finances. When Mr. Volcker raised interest rates in 1980, U.S. government debt to GDP was 30 per cent. Heading into the financial crisis of 2008 it was 60 per cent, and today it is 120 per cent, Mr. Einhorn said. Furthermore, the Congressional Budget Office estimates the federal government’s deficit in 2022 will be US$1-trillion and double that in 2030.
What comes next: stagflation or a recession?
Goodbye TINA? The stock market is facing competition from the humble GIC
Government debt is becoming so large that the interest expense arising from an increase in Fed rates above 4 per cent would begin squeezing spending on crucial public programs. For example, U.S. baby boomers are now retiring at a rate of 10,000 people a day, placing heavy and rising demands on government old-age security programs, he said. “Social Security trust funds are projected to be used up in 12 years and are already sellers of Treasuries.”
Others may also mention that another government spending imperative arises from escalating geopolitical tensions. The commitment to ensure the United States does not fall behind in new military technologies, such as hypersonic missiles, and to support regional wars, such as the one in Ukraine, is another vital case.
The spectre of a new Cold War raises the possibility that some central banks switch their reserves away from U.S. currency and bonds into gold. Mr. Einhorn said that Russia’s central bank had raised its gold holdings to one of the highest in the world, at 22 per cent of reserves, before the United States froze its remaining U.S. assets after the invasion of Ukraine.
Most other countries are far below Russia’s percentage of gold reserves and have large holdings of U.S. liabilities. For example, China owns more than US$1-trillion in U.S. bonds (purchased to suppress the yuan and thus boost exports), but less than 4 per cent of its reserves are in gold.
“When countries stop trusting each other, gold becomes the ultimate reserve asset. And I say gold, not cryptocurrencies, because gold is already recognized as a globally acceptable central bank reserve asset.”
Mr. Einhorn also discussed problems arising from supply constraints. Many of these will resolve on their own and the higher supplies will help moderate inflation.
However, the elephant in the room is the oil and gas sector. The environmental, social and governance movement has thwarted investment in traditional sources of energy, he argued. So the supply boost from higher prices could be a long time coming, especially considering Group of Seven countries have pledged to stop most fossil-fuel financing by the end of 2022.
Mr. Einhorn lamented that government policy makers are not even discussing fiscal austerity. They are leaving the inflation battle solely on the shoulders of the Fed. “To me, this means inflation isn’t going away so fast,” he said.
“The Fed will do what it can and maybe it will work. … But as rates cross above 3, maybe 4 per cent, either inflation will come down or the Fed will have to capitulate to inflation. It can’t do more because it must ensure the Treasury can fund itself. When the Fed has to choose between fighting inflation and supporting the Treasury, I think it has to pick the Treasury.”
Special to The Globe and Mail
Larry MacDonald can also be found at Investing Journey (larrymacdon.substack.com/archive)
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.