“Deficits don’t matter.” That’s the rallying cry for those who support the idea of modern monetary theory (MMT). It’s a simple enough idea. The government can spend as much money as it wants – whether to fund the healthcare service; pay for policing, firemen and teachers; or to build aircraft carriers, roads and railways. The only time it needs to worry about the quantity of money it is spending is when inflation increases.
Every consumer is familiar with inflation, but economists just don’t seem to see it. When we look at what we are spending on rent, cars, petrol, insurance, train tickets, Sky, Netflix, Microsoft, food and schooling, we can see prices rising.
Most of those are inconveniently volatile and so are excluded from what economists consider to be inflation. The one thing that has not moved, and which is very definitely part of what economists consider to be inflationary, is wages. Wages have gone nowhere for a long time, which is a key reason for economists concluding that inflation is no longer a problem.
As the saying goes: “there is many a slip between cup and lip”. If you really want to know where the recent surge in populism has sprung from, it’s down to this gap between the experience of regular people and the perception of the academics who make policy decisions. The funny thing about politicians is that they see something that has lasted a long time, assume it will last forever, and then make decisions based upon that assumption – which then upsets the balance. That’s what we are now seeing with the debates over MMT.
MMT is already being practised
Yet all of this discussion is missing one key point – we already have MMT. When the Japanese announced a deal between the government and the central bank to print a ton of money, and to loosen the public purse strings, in the hope of sparking inflation, they didn’t call it MMT – they called it “Abenomics” after Prime Minister Shinzo Abe, whose policy it was. It’s still under way seven years later.
At end of last year in the US, the Federal Reserve did a complete about-turn. It decided it was done with raising interest rates and reducing the size of its balance sheet. Government bond yields had been rising, people were worrying about a recession and the US government had hundreds of billions of dollars in debt to refinance this year and next. What else was it to do?
The Treasury needs low borrowing costs to fund the government, or there really will be recession because it would have to hike taxes to get the money. There may be no formal agreement between the central bank and government, but the result is the same. The deficits continue to mount and the central bank will do nothing to arrest their growth.
What really gets gold moving
When a government spends money it doesn’t have, for what are often vanity projects or appeasement payments to workers who feel disenfranchised, that is directly inflationary. When central banks are constrained from raising rates, you have the conditions for negative real rates (where the interest rate is below the inflation rate). Many people think gold does well in an inflationary environment because it rallied strongly during the 1970s.
Others believe gold is a hedge against deflation because it did so well between 2001 and 2011. But the real reason gold did well in each of these rather different environments is due to negative real rates. Gold does not pay an income. So when real interest rates are high and rising, other assets – which do pay an income – are more appealing. But when real rates are negative – so that it effectively costs you to own an income-paying asset – gold’s lack of yield is no longer a problem. That is when money really starts to move into precious metals and gold in particular.
Politicians globally have now observed that experiments with money printing and deficit spending have not yet led to the collapse of the financial system, or galloping inflation. So they are starting to promise huge spending programmes to capture the imaginations and votes of those who are dissatisfied with the status quo. They know as well as the rest of us that the politician who makes the biggest promises usually wins the election.
As a result, the base case has to be that we are heading for negative real rates, and gold is going to take off. If you don’t already own some – either to hedge against inflation or against financial mismanagement – it’s time to think about allocating some of your capital to the yellow metal.