Gold served as base money for thousands of years prior to 1933.
In other words, gold served as the foundation of our monetary system. It was the monetary reserve upon which the financial system operated. Even when gold coins were not used to settle transactions in the private sector, the banks would redeem the paper currency in circulation for gold upon demand.
That all stopped in 1933. That’s when the United States and other countries transitioned to fiat currency not redeemable for gold. By the way, the word fiat is Latin for “let it be done”.
This transition paved the way for The Age of Paper Wealth. It lasted forty years from 1982 to 2022. During that time the world’s central banks created trillions of dollars out of thin air to drive interest rates down and stock prices up.
But that era is over now. The Fed’s aggressive rate-hiking campaign last year marked the end of it.
So if The Age of Paper Wealth is over… what do we think that means for gold going forward?
I think it’s wildly bullish.
We aren’t going back to the days of using gold as base money. But we can’t ignore the fact that the US government still owns 8,133.5 tons of gold. That’s worth over half a trillion dollars at current prices.
And official records suggest that the world’s central banks hold 26,866.5 tons of gold. That’s worth over $1.7 trillion today.
These numbers aren’t large in the big scheme of things with gold priced around $2,000 an ounce. But they could become significant if the price of gold roared higher.
This shows that the world’s central banks never abandoned gold… even as they worked hard to convince people that gold was a “barbarous relic”, as famed economist John Maynard Keynes put it.
Why is that?
Why did the central banks hold onto their gold for all these years? And why have some central banks actively bought more gold recently?
Central banks around the world bought over 1,100 tons of gold last year. That’s the largest annual buying spree on record.
Here’s the story nobody else is talking about…
Gold Is About to Be Re-Monetized
Yesterday we talked about how the Fed is dead-set on normalizing interest rates. They have to if they want to save the legacy financial system and the American economy.
So the Fed isn’t raising now just to cut rates significantly later. And this presents the US Treasury with a major problem.
Today, the average interest rate on the US government’s outstanding debt is just under three percent. But roughly 40% of that debt is coming due over the next three years. That’s somewhere around $13 trillion.
Obviously the US government cannot afford to pay this debt off outright. It’s set to run annual deficits well in excess of $1 trillion over the next ten years.
That means the debt coming due will need to be rolled over. The Treasury will need to issue new debt at today’s higher rates just to pay off the old debt.
This sets the stage for a massive budget crisis.
The Congressional Budget Office (CBO) projects that the US government’s debt service costs will hit $745 billion by the end of next year… and then rise to $1.4 trillion by 2033. That would make debt service the second largest line-item in the federal budget—second only to Social Security and Medicare payments.
So if I’m right that the Fed is dead-set on normalizing interest rates, the US government will have to reduce its spending dramatically in other areas to satisfy debt service costs.
That is, unless the Treasury can figure out a way to roll over that $13 trillion at a much lower interest rate… even if the Fed doesn’t cut.
How could it do that? By re-monetizing America’s gold hoard.
Remember those 8,133.5 tons of gold we talked about earlier? Suppose the US Treasury agreed to settle a portion of its maturing debt with this gold. Meaning, when the Treasury paid off a bond coming due, it paid out a portion of the balance in gold.
That’s gold re-monetization.
This could lend itself to a tiered system of sorts. The Treasury could sell bonds with various degrees of gold backing at corresponding rates. For example, a 1% gold-backed bond would carry a higher rate than a 5% gold-backed bond. But both would pay lower rates than a standard U.S. Treasury bond with no gold backing.
See how this works?
Gold re-monetization would allow the Treasury to sell bonds at a lower rate than it otherwise could. In turn, this could allow the government to manage debt service costs even with higher rates.
This would also make Treasury bonds attractive again to foreign countries and central banks. That’s big.
The Treasury will need to sell around $13 trillion worth of new bonds just in the next three years. If the Fed stands pat on its resolve to normalize rates, it can’t be the buyer of last resort anymore.
So the Treasury will need to drum up significant demand for its bonds among the world’s major financial institutions and central banks. Yet, the US government’s creditworthiness is not trusted as much as it once was.
In fact, Fitch Ratings just downgraded the United States’ sovereign credit rating in August. Fitch cited “expected fiscal deterioration over the next three years” as the key driver behind its decision.
It’s no secret—the US Treasury is in a tight spot.
Gold is the solution. Gold re-monetization is how it can attract the foreign investment it needs in the years to come.
And make no mistake about it – foreign central banks remember what JP Morgan said in 1912. Gold is money, everything else is credit.
The Big Opportunity
If we find ourself in that world – a world where the US is re-monetizing its gold stash – what do we think would happen to the price of gold?
It would go much higher. Especially if the US government cracked down on naked short selling in the paper gold markets…
Naked short selling occurs when an entity shorts gold futures contracts without actually owning the physical metal required for delivery. This can serve to artificially suppress the spot price of gold.
It’s not entirely clear how prevalent this practice is, but JP Morgan did pay $920 million in fines in 2020 for manipulating the gold futures market. We know it happens to some degree. Suddenly the US government would have an incentive to put a stop to it. Because it would want a higher gold price to support its re-monetization program.
So, the stage is set for a roaring bull market in gold over the next several years.
We need to understand that these macroeconomic conditions are now in the driver’s seat when it comes to gold’s price. Gold will not trade inverse to interest rates going forward.
And that means it’s time to build exposure to the best gold equities on the market.
We discussed the need to own physical gold when we talked about reserve assets last week. Moving 5-8% of our portfolio into gold equities as well can add some real pop to our gold holdings.
I’m most partial to the best gold royalty companies right now. These are firms that provide creative financing solutions to the mining companies in exchange for royalty and streaming rights to the total production of mining operations.
Royalty companies have far fewer operating costs than the gold miners. And they build diversified portfolios of royalty and streaming rights.
That makes their income far more stable… which allows them to pay consistent dividends. We can reinvest those dividends to put the power of compound interest to work for us.
So we want to anchor our gold equities allocation with the best royalty companies.
Then we can take some shots on a few gold mining stocks when it becomes clear that the price of gold is about to kick. They are far more speculative. But the returns can be outstanding if you get the timing right.
-Joe Withrow
P.S. We’ll talk about consumer goods inflation hedges tomorrow. That’s our fifth investment “bucket”. Then next week we’ll get into the break between the Fed and the US Treasury… which I alluded to today.
And if you would like more comprehensive guidance on how to implement these investment themes, and then begin building passive income on top of them, check out The Phoenician League. All the info is right here.