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Concerns about rising budget deficits and government debt revived the debasement trade this month and sent the gold price soaring. In France, a prominent presidential candidate even proposed ‘burning’ government bonds to reduce the enormous debt burden.
Over the past month, the prices of gold, silver, bitcoin and other assets soared. Since the beginning of August, the gold price in euros has risen by more than 12 percent. In the latest Holland Gold Monthly Update, Paul Buitink cited declining confidence in governments’ ability to finance their enormous debts as the main explanation: “It all has to do with the debt position of the US, but also with that of other countries.”
Western governments are failing to bring their budget deficits under control, causing their debt-to-GDP ratios to continue rising. According to Paul, market discipline is now returning: bond investors are waking up and realising that this path will ultimately make government debt unsustainable. They are selling government bonds or demanding higher yields, pushing these governments’ interest costs even higher.
Rising interest costs are increasing the pressure on governments and central banks to bring down long-term interest rates. Paul expects central banks eventually to turn the money printer back on and resume purchasing government bonds with newly created money, otherwise known as quantitative easing (QE): “Ultimately, everything leads down one road, and that is the road of QE … Interest rates like these are simply unsustainable.”
Through QE, central banks can push down bond yields and therefore governments’ financing costs, but this comes at the expense of the currency’s purchasing power. The larger amount of money in circulation can lead to higher inflation and currency debasement. Investors therefore seek protection in gold and other ‘hard assets’, whose supply cannot be increased without limit.
Paul is not the only one expecting the gold price to rise further. Jurrien Timmer, Director of Global Macro at Fidelity Investments, wrote this week: “Based on the growth in global liquidity, gold is worth at least $5,000 per troy ounce, and probably more if global money supply growth starts accelerating again.”
John LaForge, Chief Alternative Strategist at NDR Research, is also bullish on gold. In an interview with Kitco, he said the gold trade is essentially simple to understand: the long-term trend will remain upward until governments around the world finally confront their mounting debt burdens.
According to LaForge, governments have few politically palatable ways out of their debt predicament. “There’s no way to pay this thing beyond just debasing everything,” he told Kitco. “This is the biggest tailwind gold has had.” LaForge therefore believes there is still plenty of room for the gold price to rise further.
Influential economist Robin Brooks writes in his blog about rising long-term yields that the debasement trade has returned. An alternative explanation is that long-term yields are rising because companies are competing for a limited supply of capital to build out AI infrastructure. According to Brooks, however, the data overwhelmingly point to enormous budget deficits.
US non-financial companies are still net savers. It is the government that is absorbing the available capital. “It is the government’s negative savings, in other words the budget deficit, that are absorbing the available financial resources,” Brooks said. According to him, this is a classic case of government spending displacing private investment, also known as crowding out.
Because we have already discussed the US debt problem and Scott Bessent’s actions extensively in our podcast, we now turn our attention to a striking story from that other country that features so often in our analyses: France. Politico writes that a ‘debt bomb’ has been thrown into France’s presidential debate. Bloomberg uses an even sharper headline: “The ‘Burn the Bonds’ Stage of the Debt Cycle Is Here.”
Jean-Luc Mélenchon (source: Flickr/jlm2017)
Far-left presidential candidate Jean-Luc Mélenchon unveiled a remarkable plan this week to solve France’s financial problems. If he gets his way, a large proportion of France’s government debt will be “set on fire”. Mélenchon is not a fringe candidate: he is polling at 17 percent, tied for second place with Édouard Philippe, giving him a serious chance of reaching the second round. There, he would probably face Marine Le Pen, who is currently leading the polls.
France’s government debt has now risen to more than €3.5 trillion, equivalent to 117.5 percent of GDP. We have previously written about how difficult it is to structurally reform the French budget. Attempts to curb spending and reduce the budget deficit repeatedly encounter fierce public and political opposition. Predecessors of current Prime Minister Sébastien Lecornu were even brought down by it.
According to Mélenchon, the French economy is teetering on the brink of a recession and is now at risk of actually sliding into one. He therefore believes the ECB should freeze European government debt, starting with the debt incurred during the COVID-19 pandemic. Earlier this summer, he promised to “set fire to” the debt held by the Eurosystem. The Eurosystem, comprising the ECB and the national central banks of the eurozone countries, owns approximately one-sixth of France’s government debt.
Uncertainty surrounding the new French budget and Mélenchon’s radical proposal are causing growing unease in the bond market. It is far from certain that the budget will be approved; if it is not, the budget deficit will probably widen further. Against this backdrop, the spread between French and German ten-year government bond yields has widened to a level rarely seen since the euro crisis. French bank shares also took a beating this week.
Mélenchon’s opponents warn that his plan will only exacerbate France’s budget problems. Prime Minister Sébastien Lecornu described the proposal as “fraud in its purest form” and said that households and businesses would ultimately foot the bill. “If France, which needs to raise €310 billion this year, fails to honour its own debt obligations, who would still lend us money? At best, lenders, if they are willing to lend to us at all, will demand exorbitant interest rates,” Lecornu said.
Jeroen Blokland writes that currency debasement would be the inevitable consequence of Mélenchon’s plan. According to him, writing off government bonds amounts to monetary financing, undermining the credibility of both France and the ECB. Moreover, the liability does not magically disappear: the Eurosystem loses an asset while its liabilities remain in place. Ultimately, someone has to foot the bill.
According to Blokland, the consequences would not be confined to France. The Eurosystem also owns large quantities of government bonds issued by other eurozone countries. Investors may therefore begin demanding higher yields on the debt of countries such as Italy as well. To prevent another European debt crisis, the ECB could subsequently be forced to purchase even more bonds. Blokland therefore sees scarce assets such as physical gold as the most appropriate way to protect your wealth. We will, of course, continue to monitor the situation for you!
