If we constantly borrowed and spent more than we earn while debts piled up; our house of cards will eventually collapse.

Over a decade ago, P.J. O’Rourke warned:

“Alarm bells should be ringing very loudly as the United States contemplates a deficit for 2010 of more than $1.5 trillion – about 11% of GDP….

…. Empires behave like all complex adaptive systems. They function in apparent equilibrium for some unknowable period. And then, quite abruptly, they collapse.”

The 2010 numbers now look tame. The Committee for a responsible Federal Budget predicts:

“In light of the enactment of the year-end spending and COVID relief deal, we estimate the deficit will total $2.3 trillion for Fiscal Year (FY) 2021. …. It would be higher than any other time in recorded history outside of World War I.”

The Wall Street Journal (WSJ) reports:

“The federal debt is projected to almost double to 202% of gross domestic product by 2051….”

Dr. Lacy hunt believes the historic debt levels cause economic activity and the standard of living to decline.

Governments worldwide believe they have a Magic Money Tree spending money they don’t have.

When the house of cards collapses, it will affect us all!

The recent WHVP newsletter, “Who is scared of Inflation?” grabbed my attention. WHVP looks at things from a global perspective.

I contacted Managing Partner Urs Vrijhof-Droese for an interview.

DENNIS: Urs, let’s get right to it.

Your opening paragraph was an eye-opener:

“Central banks have a problem. No matter what they do, investors are not satisfied….

…. When thinking about the central bank’s functions you will find a variety of duties but nowhere will you find their raison d’etre as pleasing investors.

…. Printing endless money and keeping up purchasing programs did please investors. But not necessarily the general public.”

Our US central bank is owned by “member banks”; now the top brokerage firms, controlling trillions of dollars in investment capital.

Despite the stated mission, our central bank is hell-bent on protecting THEIR investment profits. One former Fed chair talked about the effect on the general public as “collateral damage”.

Is this the same everywhere? Do other central banks operate differently?

URS: Hi Dennis. I appreciate the opportunity to share our perspective with your readers.

After the financial crisis, enormous amounts of money were magically created by central banks while interest rates hit historical lows. Since this strategy helped prevent the financial system from collapsing, the central banks continued on; particularly when reacting to the consequences of the coronavirus.

Basically, the central banks printed money for their governments to spend. Protecting the economy from a tsunami of bankruptcies helps, but this behavior does not come without costs. Those who suffer most from these costs are the “normal people” who are trying to save money for the future.

Today “normal people” must bear much higher risks to get an inflation-beating return. That is the “collateral damage” the general public is feeling.

Flooding the system with money and keeping interest rates low are not the only concerns. Eventually many are unable to pay for housing. The RBNZ (Central Bank of New Zealand) recently announced the new goal of stabilizing house prices. Recently housing prices in New Zealand have been rising by nearly 20% year on year. US housing prices are also soaring.

The behavior of central banks around the world is problematic because the central banks’ board and decisions are not justified by a democratic process.

DENNIS: The low-interest rates have certainly impacted savers; particularly retirees. Central banks create magic money and engineer low-interest rates, even negative rates.

You mentioned fixed-income investments are safe from default but very high risk. Please explain what you mean.

URS: Over the last decade, the environment has changed, encouraging borrowing and spending as opposed to lending.

Bond interest rates are based on the central banks’ interest rates. In Switzerland, interest rates are at negative 0.75%. Investors do not even require a risk premium offering a positive return. Credit Suisse, which had some quite negative media coverage recently, issued a bond maturing in mid-2025 with a negative annualized return -0.325%; while the inflation rate in Switzerland is still positive.

The central banks and government’s emergency programs prevented a tsunami of bankruptcies; while creating “zombie companies”. Central banks made it possible for unprofitable companies to borrow money at historic low-interest rates. In due course, inflation and interest rates will rise and many will collapse; as you said, like a house of cards.

DENNIS: How does this affect investment strategies?

URS: When formulating an investment strategy, you normally diversify the investments into the different asset classes; cash, fixed income, equities, commodities, and alternative investments. You also have to look at individual versus institutional investors.

Institutional investors, like pension funds, cannot just change the asset allocation like individual investors. Therefore, they have to pay whatever the prices are just to comply with their required allocation. Unlike buying and holding bonds for income, they are trading them just like equities. They want interest rates to go even lower so there is someone willing to pay even higher prices for the bond.

This game works as long as everyone believes that it does and is able to act this way. While many central banks feel they are almighty, we do not believe that this will end well.

Fortunately, individual investors are not bound by asset allocation guidelines and can diversify their assets more safely and productively.

DENNIS: Under the heading, “Who is scared of inflation” you mentioned:

“…. Central banks are in a difficult situation. On one side, they must go along with whatever stimulus package the government releases and on the other side, they have to comply with their legal obligations.”

The US central bank welcomes any stimulus package and much of it is directed toward their best interest. They skirt around US law.

If central banks all over the world are creating currency out of nothing, because the US is not in negative territory (yet), wouldn’t that temper US inflation?

What countries do you see experiencing the inflation threat first?

URS: We do not see negative rates by other central banks having a major impact on US inflation. While US yields remain barely positive, they do not beat the US inflation rate.

The inflation we are expecting now is due to the higher commodity prices and de-globalization. Bringing production chains closer, or even back into your country, adds a cost which might lead to higher prices. In some fashion, these costs are eventually passed on to the consumer, leading to inflation.

However, in the mid-to-long term, competition will become more important again and therefore the prices might come back down, leading to disinflation or possibly deflation.

DENNIS: You also mentioned the current strength of the USD may be temporary. Please explain to our readers why you feel that way.

URS: In the first quarter, the US surprised global investors with their speed when it comes to vaccination. Last year we saw a lot of interest from investors in Asia because Asian countries handled the virus quite well.

Investors are associating aggressive vaccination programs with a quicker re-opening of the economy. Hope and positive economic expectations will often be coupled with cash flowing into these areas, creating a high demand for that specific currency.

Things are materializing and therefore investors are motivated to invest again. We are in a fast-moving environment.

Europe lagged, but will eventually pick up with its vaccination program, creating more investor interest; with cash flowing out of the USA into Europe. Investors will liquidate some of the short-term gains and move money to other regions offering higher returns.

The huge stimulus packages, with the possibility of more to come, raises concern about the ability of the USA to cover their debt; which you mentioned in your opening remarks. We agree the high debt will negatively impact economic growth in the US.

Also, Asia and Russia have a problem with the USD being the global reserve currency. According to the WSJ, the USD’s share of global reserve moved to its lowest level since 1995. We believe that this ongoing depreciation of the USD will continue, at least until 2023.

DENNIS: One final question. This unprecedented debt expansion means we need to diversify, including currencies. How are your clients spreading their risk throughout the world?

URS: Exactly, it is more important than ever to see other currencies as investment opportunities. Our clients are invested in many different countries.

We start by considering the potential of the specific currency against the USD. We are very picky when it comes to fixed income, however, we occasionally find a great opportunity. We can also invest in stock markets around the world and hold the investment in any number of currencies, offering even more diversification.

Currently, we are low on bonds and prefer stable equity investments including precious metals; a hedge against inflation of every currency.

Our investment team does their homework and strives to be sure our clients have a balanced portfolio.

DENNIS: For those who are interested, they have published a great in-depth inflation primer. Thanks again for your time.

URS: My pleasure.

Dennis here. The house of cards is getting wobbly. Investing cautiously, diversifying your capital among asset classes (including internationally), keeping things balanced, and staying on top of things will keep your foundation strong. When the collapse comes, some great investment opportunities will appear.