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If you think the last federal election was a doozie, get ready, because 2020 promises to be off the charts.
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Trump is likely running again, and against vocal adversaries like Bernie Sanders, Elizabeth Warren, and Alexandria “AOC” Ocasio-Cortez. So the mud-slinging and clashes will reach new heights – or depths might be the better word.
They’ll be offering free health care and college, guaranteed jobs, universal basic income, and the “Green New Deal.”
They’ll be telling you the way to this utopia is through something called modern monetary theory, or “MMT.”
Voters will be led to believe that it’s all easy to pay for by just printing money, and that deficits won’t even exist.
But don’t buy it; there is no free lunch.
Either you or your kids will be paying for these goodies through higher taxes, inflation, or both.
Ultimately, your financial health is yours to protect.
And one asset class is uniquely positioned to do this job best.
Let’s take a look…
Making an Already Flawed System Worse
Modern monetary theory is an idea that’s gaining a lot of traction in the lead up to next year’s election.
Just recently, Congresswoman Ocasio-Cortez expressed her support for MMT.
And why not?
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AOC thinks MMT would allow for the funding of large social programs, like her Green New Deal, without any downside.
Deficits? There won’t be any. Debt? A thing of the past.
Under an MMT system, the U.S. Treasury would not issue bonds to fund its deficits. Instead, it would simply print money directly and spend it as it wished.
Naturally, creating money from thin air and spending it on a limited supply of goods and services will lead to inflation. There’s simply no way around it.
Also, this money spent by the public sector still takes limited workers, time, and physical resources away from the private sector.
Under MMT, the government’s tool to cool inflation is taxes. If inflation slips too much, taxes could cut them. In theory, higher taxes would help to slow spending as the economy heats up.
That means Congress would then be tasked with managing the business cycle.
Ah, but that’s assuming they’re willing to raise taxes… not the most popular move, unless it’s on the rich.
Under our existing system, it’s the Fed who’s responsible to help cool inflation through higher interest rates. And yes, we have deficits – big ones – from the Treasury issuing debt for the funds to spend.
AOC says as long as deficit spending is on productive programs, like her Green New Deal, then it’s OK.
The Chairman of the Federal Reserve, however, begs to differ.
The Government Won’t be Able to Pay Its Bills
Chairman Powell recently said during congressional testimony in the Senate, referring to MMT and its growing support to pay for social programs, that “The idea that deficits don’t matter for countries that can borrow in their own currency I think is just wrong…” – in part because congressional reaction to inflation, by raising taxes, would be slower than the Fed’s ability to raise rates.
Powell said some “pretty extreme claims” are being ascribed to MMT, admitting that he hasn’t really “seen a carefully worked out description of what is meant by MMT.”
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He went on to warn the committee that debt is rising faster than GDP. Fiscal 2018’s deficit at 3.85% of GDP is dangerously close to the 4% most business economists find worrisome.
According to Powell, there is “real uncertainty” about the government’s ability to pay its bills, and that “debt cannot grow faster than GDP forever.”
One thing that’s often repeated by MMT proponents is that if the Fed can keep rates low and avoid inflation, then deficits and the national debt are not a concern.
But here’s where it gets tricky and the Keynesians are happy to stay quiet.
A Vicious Cycle of Print, Spend, Print
Under our current monetary system, if the government continues to run large and growing deficits, it needs to keep issuing debt to cover those deficits. That makes the national debt grow at an accelerating pace; the concern highlighted by Powell.
This will turn into a vicious cycle of printing, spending, and printing some more. At some point, the money that’s printed is spent overwhelmingly just to pay the interest due on the outstanding debt.
After all, if you hold government bonds or treasuries, you fully expect to get your interest. And you will. However, there comes a point when markets will start to discount the value of those bonds. Each bond will be worth less as the outstanding inventory multiplies in size.
Now add rising interest rates to the mix. Then imagine financing a trillion-dollar deficit and the accumulating debt at 7% or even 10% for 30 years.
I know, the Fed can keep short-term rates low as long as it wants, technically. But not raising them soon enough challenges its credibility, kind of like right now.
Besides, long-term rates are market-driven. Once participants lose faith and start to sell their bonds aggressively, that will drive long-term rates higher. They will want a return commensurate with risk.
That will be “game over.”
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Research by economists Rogoff and Reinhart after looking at 800 years of history says a national debt above 90% of GDP becomes problematic.
Right now, the U.S. debt is already at 105% of GDP. And it’s expanding rapidly. According to Congressional Budget Office estimates, the debt is expanding at a 6% rate annually.
Eventually, the bond or currency markets will blink, and a financial crisis will be at hand. Markets will take care of government-caused distortions.
Today, there’s $11 trillion in government debt globally that pays a negative interest rate, mainly in Europe and Japan. That means investors get less than their original money back for the “privilege” of holding government debt.
How long is this likely to last?
Let’s face it: If it were as simple as printing your way to prosperity, then Venezuela would be the latest “richest nation on earth.”
Instead, it’s a failed state with inflation running at a cool 1 million percent annually. In 2017, the average Venezuelan lost 24 pounds due to the lack of food. Since 2015, about 3.3 million Venezuelans have fled to neighboring countries – not exactly a model of prosperity.
Raising Taxes Is an Unreliable Solution
Given that MMT technically allows limitless government spending while eliminating deficits, expect candidates on both sides to warm up to the ideas of MMT. But know, too, that it will alert markets to the risks associated with ever larger-deficits as candidates downplay them.
While MMT is supposed to have the government increase taxes to tame inflation, that’s much too unpopular.
Best let the people blame those greedy capitalists instead for raising prices faster than their income.
As investors look for hedges against inflation risks, owning hard assets is the surest way to protect against shenanigans like the modern monetary theory.
The Perfect Scenario for Gold to Shine
Make sure to own at least some physical gold and silver, especially in the form of well recognized coins like American Eagles, Canadian Maple Leafs, South African Krugerrands, or even the Austrian Philharmonics.
A gold-backed ETF that I like is the VanEck Merck Gold Trust (NYSEArca: OUNZ). It has about $155 million in assets and charges a reasonable 0.4% management fee. One of its most attractive features is the ability for unitholders to take physical delivery of their gold in the form of bars or coins.
Of course, gold equities are somewhat of a proxy for gold, albeit with more volatility.
Rather than a major gold miner, consider instead a large gold royalty company. Franco-Nevada Corp. (NYSE: FNV) has the largest and most diversified portfolio of cash-flow producing assets. It’s a $14 billion company with growing dividends. It’s paid out over $1 billion in dividends since its IPO. And it does all this with just 32 employees.
Moving up the risk scale leads us to mid-tier gold producers. Leagold Mining Corp. (TSX: LMC, OTCQX: LMCNF) is a Latin America-focused gold producer. Its strategy is to “buy and build” with the aim of growing through acquisition. Leagold owns four gold mines and two development projects in Mexico and Brazil.
Los Filos is the company’s flagship asset, acquired from Goldcorp in 2017 for $219 million in cash and $71 million in shares, with Goldcorp becoming a 30% Leagold shareholder. This mine has just set a new quarterly production record for Q4 2018.
The Los Filos expansion and Santa Luz restart could help nearly double Leagold’s production over the next few years.
While carrying still higher risk, gold explorers also offer moonshot potential. Minaurum Gold Inc. (TSX: MGG, OTCQX: MMRGF) is a junior gold miner focused on Mexico. Its stewards include geologists responsible for discovering Mexican deposits containing over 300 million silver ounces and 10 million gold ounces.
In fact, company director Peter Megaw is a professional geologist instrumental in discovering three of MAG Silver’s (NYSE: MAG) main properties, as well as Excellon Resources’ Platosa Mine. Director David M. Jones consults to major miners like Teck Corp. and BHP Billiton. He discovered the Los Filos gold deposit currently owned by Leagold.
Minaurum’s business model is simple; acquire district-scale projects, add value and advance them through drilling, then eventually either spin them out as a new company or sell the asset.
The company is run like a tight ship, with a $114 million market cap and $10 million in cash.
There are three main assets: the Alamos silver Project in southern Sonora State, the Santa Marta gold-copper project in the Oaxaca-Chiapas region, and the Vuelcos Del Destino gold project in the Guerrero Gold Belt.
Minaurum’s share price has far outperformed the average gold stock over the past three years. And given the quality of its management, directors, and outstanding assets, I expect that outperformance to continue as suitors look to acquire great projects.
Next year’s federal election will see campaigning starting soon, and the promises for goodies will flow. Expect to hear MMT bandied about as both sides tout the theory as a panacea.
But be mindful. The U.S. dollar is likely to suffer as deficits swell and markets realize Washington is allergic to fiscal responsibility.
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