Gold, Silver, and the Theater of "Tough Talk"
Gold recently sold off by about $50, settling around $4,135, with another $18 of decline stacked on top of that as I write. Silver fell 58 cents to trade just over $64, after being down more than a dollar the prior Friday. Much of this weakness was driven by aggressive rhetoric from the incoming Fed chair, Warsh, who has been talking tough about fighting inflation and restoring price stability.
I don't believe a word of this tough talk. Talking tough is easy; walking the walk is the hard part, and it isn't going to happen. Warsh is simply trying to establish credibility — the new sheriff in town, determined to make a lot of noise, promising he'll do what Powell failed to do and finally crush inflation. He won't. He will fail for exactly the same reason Powell failed: he cannot actually fight inflation, he cannot shrink the balance sheet, and he cannot raise interest rates high enough. This is the very same trap that paralyzes Japan, and it's why neither country is acting.
None of these politicians are willing to do what it actually takes to solve the problems they themselves created. The one thing they can do is pretend they're willing to solve them — but they can't genuinely try, because doing so would expose the real gravity of a situation they refuse to acknowledge. For this reason, every selloff in gold is simply an opportunity to buy more. The same logic applies to the recent strength in the dollar, which has firmed up on an expectation of tightening that will never materialize.
Why the Fed Cannot Act
Even if the Fed follows through with a couple of quarter-point rate hikes, it won't matter — it's spitting in the ocean. What the Fed would truly need to do with both interest rates and its balance sheet, it is simply not going to do. The evidence is in the numbers: last week the government balance sheet expanded by another $11 billion. If Warsh genuinely intends to be tough on inflation, why did he expand the balance sheet? What is he waiting for? Why didn't he already raise rates? Why didn't he vote for a hike in his very first meeting?
The answer is that he doesn't want to. He wants to talk about fighting inflation and collect credit for the talk, but he doesn't want to act, because he doesn't want to deal with the consequences of acting. Yet the consequences of not acting will be far worse — just as the consequences of Japan's inaction will be far worse for Japan. So why don't they act? For the same reason our politicians and bankers don't: they don't want to deal with the problem today. They want to kick the can down the road and hope someone else handles it tomorrow, even though that someone else will inherit a bigger problem with even more profound consequences.
These are politicians. They don't care what ultimately happens to the country; they only care what happens while they're at the helm. They don't care if the ship crashes after someone else takes the wheel — they just want to make sure they aren't blamed for it. But the truth is that everyone who has held the wheel shares the blame. Every past Fed chairman, every past president, the Bank of Japan, and Japan's prime ministers who continued down this path are all responsible. Everyone had the ability to do something, and nobody did.
The Absence of Accountability
Unfortunately, academia doesn't hold anyone accountable, and neither does the investment community, because nobody wants to upset the apple cart. A great many people are getting rich off this system, and they don't want to disrupt the gravy train — even though that gravy train is heading straight off a cliff.
Taxes, Fairness, and the Empty Promise of Socialism
A common political refrain insists that welfare and food-stamp recipients are "the deserving people." But what exactly do they deserve, and what are they contributing? The genuine question of "fair share" is aimed at the wrong group. The people who truly don't pay their fair share are those living off government, who don't even have jobs and simply collect a check. The left never tells welfare or food-stamp recipients that they need to contribute to society and pay their fair share. Instead, it points at the people contributing the most and paying the most in taxes and declares that they aren't doing enough.
The wealthy are not underpaying — they are paying far more than their fair share. If you genuinely wanted the rich to pay a fair share, you would have to cut their taxes. That is the reality.
In fact, the entire tax system is bad and should be eliminated — not because I want fewer wealthy people, but because I want more of them. I want the government to be poor and the people to be rich. The government only has what it takes, so enriching the government necessarily impoverishes the people. That is precisely what the left does, and it is the empty promise of socialism. It sounds wonderful — just take money from the rich so we can have it for ourselves — but stealing from the rich and spending their money means shooting yourself in the foot. Look at the Soviet Union, Cuba, North Korea, and every other communist experiment: every one has failed, and none has ever succeeded. Yet the left keeps touting these false promises, because the one thing socialism reliably delivers is votes. The public, especially Americans dumbed down by a failed public school system, doesn't understand the consequences. They believe the nonsense — "take his money, let us have it" — without grasping the damage it does.
Japan: The Crisis Already Beginning
The most urgent thing everyone needs to watch is Japan. The yen is genuinely starting to break down, and the currency is at a critical, perhaps decisive, inflection point. The yen sits at about 161.5 — and remember, when that number goes up, the yen is actually going down, meaning each dollar buys more yen. The level around 160 was a key threshold, and we are now through it. The Bank of Japan is intervening, or threatening more intervention, to draw a line in the sand.
But Japan has drawn lines in the sand before. Authorities once declared they would not let the yield on the 10-year Japanese government bond (JGB) rise above half a percent. That was their original line. Today that yield is at 2.65% — far above where they swore they'd never let it go. It reached as high as 2.77%, nearly 2.8%, and it is going to take out that high. There will be enormous upward pressure on Japanese bond yields. The 30-year JGB, of which there are fewer, climbed to 4% a few weeks ago; it's now at 3.78%, but it too is going to push back through 4%.
Critically, this is not a strong-dollar story — it is a weak-yen story. The dollar index is only a bit over 100, but the yen is falling against everything: against the euro, the pound, the various Southeast Asian currencies, the Australian dollar, and the Canadian dollar. This is broad-based yen weakness.
The Arithmetic of a Debt Trap
Consider Japan's fundamentals. Its debt-to-GDP ratio is roughly 250% — about double that of the United States. Japan now runs annual budget deficits of about $200 billion (expressed in dollars for clarity, though it's all in yen), which is roughly 4.5% of GDP — a very large deficit. Its total national debt comes to about 8.3 trillion dollars. That sounds small next to the United States' 40 trillion, but Japan is a much smaller country — geographically about the size of California, with a far smaller economy. The Japanese government collects only about $500 billion a year in taxes.
Now run the numbers on interest rates. Short rates aren't there yet — 2-year bonds yield about 1.4%, 5-year bonds about 1.9% — but pressure is building. Suppose interest rates rose to 4%, which is hardly outrageous, since that's roughly where the United States already sits and where Japan's long end already is. At 4%, the Japanese government would spend two-thirds of its entire tax revenue just to pay interest on the national debt. And if rates reached 6% — a level Japan has seen in the past, and far below what America has experienced — interest payments alone would consume 100% of Japanese tax revenue. This is an incredible crisis in the making.
The Reserve Cushion and the Vicious Cycle
There is a chance of pronounced weakness if the yen breaks down here. This is a genuine crisis. The Japanese government does hold about 1.2 trillion dollars in foreign reserves, the vast majority in US Treasuries. They will need to sell those at a minimum — but doing so would only repay about 15 to 16% of their national debt. Dumping all their Treasuries wouldn't get them out of jail, but it's at least something, and they'll have to do it. Even before that step, a breakdown in the JGB market and the yen alone will be a serious problem. Yet right now the government is doing nothing. It continues running large deficits despite this ticking time bomb. It should be running budget surpluses and paying down debt — but politically, it cannot.
Meanwhile, import prices in Japan are up 25% year over year. Some of that is war-related, and much of it is food and energy — but people need food and energy. This creates powerful upward pressure on inflation that will only intensify as the yen depreciates. A weaker yen directly drives up import prices, which puts more downward pressure on Japanese government bonds, which forces the BOJ to monetize those bonds by printing more yen to buy them, which further weakens the yen, which pushes prices and bond yields up again. It is a self-reinforcing vicious cycle from which there is no easy escape.
America's Future, From a Weaker Position
This is a direct look into America's future, because the United States is on the same trajectory as Japan — except we lack a large stockpile of foreign assets. We could try to sell our gold, but that would open up a whole new can of worms.
Japan, for all its troubles, still retains genuine strengths. It maintains substantial exports relative to imports, so even while running budget deficits, its trade deficits are not enormous like America's. Most importantly, Japan remains a net creditor nation — the Japanese still own more foreign assets than foreigners own Japanese assets. That gives Japan a position of strength from which to confront a massive crisis, a position the United States simply does not have.
America will enter its own crisis from a position of weakness: huge trade deficits layered on top of budget deficits, compounded by our status as the world's biggest debtor nation. All of this will magnify the problem. We just haven't experienced it yet — but it is obvious that these overly indebted governments are drawing closer and closer to a day of reckoning. And nobody important is worried about it or even talking about it. Hank Paulson did acknowledge the need for an emergency "break-the-glass" plan to deal with this crisis when it hits — notably, not a plan to prevent it, because the crisis is inevitable. There is no realistic chance we'll do what's required to stop it from happening. We have simply resigned ourselves to reacting after the fact — but reacting is not a plan.
