Chris’ note: President Trump wants the Federal Reserve to cut interest rates to zero – or less.
Here’s what he tweeted yesterday:
Trump went on to call the Fed “boneheads,” saying that by not slashing rates, we’re missing out on a “once in a lifetime opportunity”…
This is big news. After all, what Trump is suggesting – that the Fed should set negative interest rates – has never been done in the U.S.
I wanted to know how realistic this actually was… how it would affect the everyday American… and most importantly, what type of investing implications it would have.
So I called up my good friend E.B. Tucker – editor of Strategic Investor and one of the best big-picture thinkers in our business – for his take…
Chris Reilly, managing editor, Casey Daily Dispatch: Hi, E.B. So big news yesterday… Trump tweeted that the Fed should slash interest rates to zero. Or less. I’m sure a lot of our readers are wondering what negative interest rates here in the U.S. would actually look like…
E.B. Tucker, editor, Strategic Investor: Okay, so there are two huge things going on here. There’s a big difference between just lowering rates… and setting them below zero, which has never been done before in the U.S.
Let’s get into what happens in general when the Fed lowers rates first.
Remember, Trump sees things through his business history, which is in real estate. So let’s look at it like this: Say you have 5% debt on an apartment building, and you refinance with 4% debt. You free up more cash flow, so on paper you feel wealthier.
And if you can continue doing that to 3%… then 2%… and then 1%, the value of your apartment complex could effectively stay the same. But the cost for you to borrow the money keeps getting lower. So you feel wealthy.
And this happens in people’s lives, too. You see it all the time with your house. An 8% mortgage goes down to 7%, 6%, and so on. The lower it goes, the more monthly cash you have in your pocket. And so even though you’re not any wealthier (in fact, you might be further indebted), you feel wealthier because you free up more cash flow.
So what Trump is saying is, “Boneheads, lower the interest rates down to zero so that we can refinance the United States’ debt and feel wealthier. In fact, lower the rate down to negative.” So that’s his whole purpose first of all. Treasury debt under Trump has grown by around $2.6 trillion already.
You might know that I have an opinion that under every eight-year president in the United States, the national debt doubles. It’s been that way roughly back to Reagan. So we’ll see if that holds true with Trump. He’s well on his way. As the economy slows and spending goes up, and he keeps pressing for refinancing the debt, I think I’ll be right about that again.
So that’s why he’s talking to the Fed this way because what he’s saying is, “Look, refinance the apartment complex at lower rates.” It’s kind of like intimidating your banker. “Give me a lower mortgage or else.”
Chris: Got it. So what happens next?
E.B.: Treasury Secretary Steven Mnuchin has already come out and said we want to have a 50- or 100-year U.S. bond. Argentina has a 100-year bond. Austria has a 100-year bond. So there’s precedent for this.
Imagine if the U.S. could borrow trillions of dollars for, say, 1% or something for 100 years. And then you could pay that back over 100 years, which means effectively you would never really pay it back. Because the debt would be washed away with inflation. So that’s one thing we’ve got going on.
Now, where Trump takes it to the next level is when he says, “Take them even lower than zero.”
Chris: Yep. You said negative rates would be a whole other ballgame. Can you explain what that would potentially look like?
E.B.: If the Fed took rates below zero, the Treasury would actually make money by selling bonds.
What that means is, you would pay more than the value of the bond for the privilege of owning a bond. So that’s an incredible scenario for the Treasury, because the more it borrows, the more it would make. You’d pay $1,000 to get $995 back later. That’s how it works. You’d pay a premium to buy Treasury bonds in that case.
Chris: So do you think this could actually happen?
E.B.: Well, let’s look at it like this. There’s about $66 trillion of sovereign debt in the world. Sovereign debt meaning debt issued by a sovereign nation. $66 trillion. Around $15 trillion of that already trades at negative rates. What that means is that roughly a quarter of all that sovereign debt already trades at negative rates, and the U.S. is not even part of that.
So if you think about it, there’s absolutely precedent for this.
In fact, just this morning, the outgoing president of the European Central Bank [ECB], Mario Draghi, pushed European rates further negative. He lowered ECB rates to negative-0.5% and promised not to raise them until the ECB sees inflation reach its target of around 2%.
Look through the headlines and look what Draghi is really saying. Bankers will pay you negative-0.5% on your money until inflation reaches 2%. That means your money evaporates at a rate of 2.5% per year.
This next chapter in the central bank’s radical money experiment also helps irresponsible countries. Some of the world’s riskiest debt now trades with very low rates of return.
Remember, the purpose of the interest rate is to compensate you for risk. So if you loan money to a dangerous banana republic, it’s only logical that you should receive a higher rate of interest, because every once in a while, the dictator kills the other members of parliament and takes over the country. And then you don’t get paid back.
So the interest rate should compensate you for the risk of loaning to the nation. And now those rewards for loaning money have gone down so low that they’ve actually gone negative where it’s a privilege to loan money to a country.
I’m not so sure that in the long run that holds up. But it is the case right now. And I think the U.S. is going to be the next one to follow.
Chris: All right. So if the U.S. is the next one to follow, and turns to negative interest rates… what should our readers do to prepare? Are there any investing implications?
E.B.: Okay, so let’s pretend that you’ve got $100,000 in savings at the bank and you’re making 1% on that savings. That’s $1,000 a year. And then all of a sudden, the bank says we’re now going to start charging you to keep your money here.
What are you going to do with that money? You’re going to obviously pull that money out and go look for something that will at least break even for you. Because now you’re starting to worry about if you put $100,000 in the bank, and if the interest rates are negative-1%, it’s going down by $1,000 a year.
So what are you going to do if you’re the average guy? Maybe you’re going to buy stocks. Maybe you don’t like stocks, and you’re going to buy some sort of alternative investment. Maybe you’ll pay off your mortgage.
The point is, you’re going to do something with that money. And I think as this happens, you can expect people to start moving their money around with a degree of panic.
Here’s one specific place I think they’ll put that money… and I want you to think about this…
There’s $247 trillion of total debt in the world. There’s only $9 trillion worth of gold. So if you’re being charged to buy debt, why would you not buy gold? I’d say gold is much more reliable than the debt of a company or a country, which occasionally doesn’t pay you back or pays you back in cheaper dollars than you loaned them. In that case, you’re taking on risk without a return.
A lot of famous U.S. money managers criticized gold over the years because it cost money to store in a vault. If bonds cost money to store in an account, that argument against gold doesn’t work. Forget about the fact that gold is limited and the supply of bonds is endless.
So there’s such a small amount of gold in the world compared to the amount of debt that I think gold is set for a market where it could easily rise beyond people’s expectations. I mean, over a longer period of time, I think it’s logical that gold could double.
Think about it. Why can’t there be $18 trillion worth of gold and $247 trillion worth of debt? I don’t think that debt number is going to come down. If the price of gold doubled, there would still only be $18 trillion worth of gold compared to $247 trillion worth of debt. So I think that’s very logical.
To sum it up, I think stocks could potentially benefit from this because people would probably choose the stock market, where you can get a 2% dividend over being charged at the bank… but the major beneficiary would be gold.
Chris: Another reason for readers to buy gold right now. Great stuff, E.B. Appreciate the time, as always.
E.B.: My pleasure, Chris.
Chris’ note: As E.B. said, gold is a reliable way to protect your wealth… and as global debt continues to grow, it could deliver profits as well.
That’s why we want to share our free “Gold Investor’s Guide” with you. It tells you everything you need to know about buying and holding gold. And it’s a great place to start if you want to add the metal to your portfolio. You can read it right here.