“Reagan proved deficits don’t matter.”  – Dick Cheney 

Do deficits matter? It depends who you are, and it depends on the assets in question. And it depends when you ask. We’ve had plenty of reminders this week of the debt/deficit situation and what it means for markets. It’s the 4D trade – debt debasement & dollar devaluation. No surprise then that gold is trading at record highs. It’s a lot more than just central bank buying, geopolitical risk and 2025 inflation reacceleration hedging. We are into a new fiscal deficit and inflationary paradigm and gold is proving its mettle. 

‘Unsustainable’ 

This week Britain’s Office for Budget Responsibility (OBR) – a kind of quasi-independent marker of government homework – forecast that public debt would rise to over 270 per cent of GDP by the mid-2070s, up from just under 100 per cent at the moment. 

A trebling in the national debt is “unsustainable”, as the OBR puts it. But what is to be done?  

Labour has done a splendid job of showing us they are not afraid to upset. The assault on the winter fuel allowance was all about showing the government is prepared to be unpopular in order to convince financial markets they are credible. Could this suggest they want to do a Truss without doing a Truss…ie increase the deficit without unnerving bond vigilantes? We looked at whether there is any real pro-business attitude in the new government in this week’s podcast. 

Either way, no one seems to want to cut spending. Financing ‘domestic bliss and foreign wars’ requires ever higher deficits. That is, unless you can unlock and productivity miracle.  

“We have reached the point where, without action, we will have to either compromise our welfare, our environment or our freedom.” – Mario Draghi 

It was the Draghi report this week that really stood out. This had both sides of the coin – how to jumpstart Europe’s sclerotic productivity and more debt. 

Bold and plain-speaking it may have been, and full of some excellent solutions, it carried another message: more EU, more fiscal union, more debt issuance. Specifically, it called for additional investments of at least €750-800bn each year — around 4.4-4.7% of EU GDP for decarbonisation, digitalisation, and defence. This would need joint EU borrowing.  

The pandemic broke new ground and opened the door to states agreeing to joint debt instruments in times of crisis; and are we not already in a form of slow crisis? Draghi explicitly made the case: “We are already in crisis mode and to ignore this is to slide into a situation you don’t want to have.” Better to risk sticking you head in the lion’s jaws than let the rats eat you slowly. Centralised fiscal intervention may be the natural endgame. Fragmentation of the political scene and ever-growing budget deficits for the likes of Italy and France could mean leaders become keener on fiscal intervention at an EU level. 

And I go back to speech by Christine Lagarde last April, which I have repeated time and again. This, I said at the time, was “a signal that we are about to go into a protracted economic (and maybe real) war and it will require the mobilisation of the state and people – developed world central banks (Fed, ECB, BoE, BoC, RBA) will act together to orchestrate fiscal spending and suppress yields”. The pandemic showed it could be done, Draghi’s report provides the intellectual justification for centralising fiscal regimes permanently.   

However, Germany has already expressed opposition to joint EU bond issuance. The idea that the Dutch and the Germans would simply sign up to €800bn in extra spending via a joint EU debt instrument is laughable. And the report has landed at a time of increasing fragmentation and rising populism that would make improving “slow and disaggregated policymaking processes” all but impossible in the near term. But ever the technocrat, Super Mario thinks more EU, not less, is the answer. Whatever it takes, I suppose. 

You can go into all the details here. It’s worth a read – there is far too much to discuss in this one post, so I am content to discuss it solely from the point of view of deficits and debt. The productivity gap can be seen here.  

“Never waste the opportunity offered by a good crisis” – Niccolo Machiavelli 

It goes without saying that in both the OBR and Draghi reports, they go in hard with climate change. If you use the Covid experience as a template – imagine a permanent ‘crisis’ for the next 50 years that will require more government, not less, more restraints on our liberties, more fiscal coordination, more financial repression, and more taxation.  

The OBR for instance estimates that UK real GDP would be 5% lower by 2074 if temperatures are 3 degrees warmer.  

MEGA (Make Europe Great Again) Mario Draghi goes further and makes the point that you cannot apply a climate policy (net zero) without a corresponding industrial policy.  

“What the Wharton School has said is Donald Trump’s plan would actually explode the deficit. Sixteen Nobel laureates have described his economic plan as something that would increase inflation and by the middle of next year would invite a recession.”  – Kamala Harris 

In the US, the drunken sailors are adding $1tn in debt every 100 days. For the first time, the US government has spent more than $1tn on interest payments alone this year to service the $35.3tn debt. In August the deficit for this year alone moved close to $2tn. Whoever wins the November election, deficits, and the debt, will surely rise. Both candidates will almost undoubtedly raise the deficit. 

Folks at the Penn Wharton Budget Model – referenced by Harris in this week’s debate – have indeed delved into what it all means for the US deficit, and it will get worse whoever wins in November.  

Trump has endorsed several tax-related policy proposals, such as extending the expiring provisions of the 2017 Tax Cuts and Jobs Act (TCJA) and recommends additional reductions in the corporate tax rate to 15 percent.  Trump also favours eliminating income taxes on Social Security benefits.  

The Penn folks reckon this would increase primary deficits by $5.8 trillion over the next 10 years on a conventional basis and by $4.1 trillion on a dynamic basis that includes economic feedback effects. GDP would rise a bit to start but eventually falls relative to current law, in their model, falling by 0.4 percent in 2034 and by 2.1 percent in 30 years. Low, middle, and high-income households in 2026 and 2034 all fare better.  

Harris’s tax and spending proposals would increase primary deficits by $1.2 trillion (about $3,700 per person in the US) over the next 10 years on a conventional basis and by $2.0 trillion on a dynamic basis that includes a reduction in economic activity, whilst GDP falls by 1.3 percent by 2034 and by 4 percent within 30 years.   

“The depth and magnitude of the economic drop-off took modern monetary theory—or the direct monetization of massive fiscal spending—from the theoretical to practice without any debate.” – Paul Tudor Jones, 2020. 

This morning, gold extended its run higher after notching a fresh record high yesterday. Spot gold rallied to $2,570 and whilst futures continuous contract (GC00) moved within a whisker of $2,600. We are still in the new inflationary paradigm that the pandemic set in motion and which PTJ wrote about at the time. And it’s clear to me that the Draghi report lays further foundations for doing what I thought was coming – coordinated developed world fiscal and monetary policy to support growing deficits by suppressing their true cost (yields). So, kick the can even more down the road – gold is the only hard asset and is benefitting. Stocks should benefit further. Bitcoin is probably waiting on the election result and remains rangebound. 

I restate Paul Tudor Jones from 2020: 

“A simple metric based on the ratio of the value of gold above ground to global M1 suggests gold could rally to 2,400 before it reaches valuations consistent with the lowest of the last three peaks in this valuation metric and 6,700 if we went back to the 1980 extremes.” 

Deficits are rising and CBs are on side. No wonder gold is soaring. 

Deficits don’t matter…until they do. I discussed with David Buik on our podcast Overleveraged. 

Neil Wilson

Chief Market Analyst at Finalto

All opinions, news, research, analysis, prices or other information is provided as general market commentary and not as investment advice and all potential results discussed are not guaranteed to be achieved. The information may have been derived from publicly available sources, company reports, personal research, or surveys. Past performance is not indicative of future performance. Trading carries risk of capital loss. Service available to professional clients only.