The United States is a federation of individual states which have the Federal Government to oversee them and run the affairs of the overall federation or country. Thus the Federal Debt is the amount owed by the United States government to various creditors.
Figures released by the Federal Debt can usually be broken into two categories. The first categorisation is known as ‘Debt held by the public’ which details the government’s obligations to individuals and institutions outside of the United States government. The second categorization is known as ‘Intergovernmental holdings’ which are primarily United States Treasury Securities which are held by foreign governments. The sum of these two categories is also known as the Total Public Debt Outstanding. The Federal Debt specifically excludes all securities issued by local and states governments.
The level of the debt is often expressed as a percentage of its GDP (Gross Domestic Product) to enable economists and politicians to compare the indebtedness of various countries. Since the 1970’s, the level of Federal Debt to GDP has risen from 26% to approximately 62% by the end of 2010. It is worth noting that during World War 2 the percentage was in excess of one hundred percent and took until the 1970’s to reduce it to 26%. The debt arises when the government’s receipts exceed its revenues over a particular period.
The Federal Debt level is a contentious political issue with conservatives usually wishing to reduce government spending (and the size of the Federal Government) and borrowing whilst more liberal politicians are generally more pro-government and more sympathetic to government borrowing. The Federal Government in the United States has always operated with a Federal Debt. Historically, this has arisen due to the various wars fought by the United States and the government has generally pursued a policy of paying down its debt through budget surpluses in times of peace.
Federal Debts are repayable in United States Dollars and are generally issued with fixed rates of interest. This tempts the government to reduce the real value of its debts through allowing inflation to rise. Rising inflation reduces the real value of the money to be re-paid. These policies undermine confidence in the currency and could make future attempts to borrow money more difficult or give rise to the need to pay higher rates of nominal interest.
Federal Debt and Gold
Although monetary policy often seems to be more important, fiscal policy may also be a significant driver of gold prices. When a fiscal deficit arises and federal debt accumulates, this undermines the confidence in the economy and thus spurs safe-haven demand for gold. To a large extent, this is because high indebtedness triggers worries about inflation, as, historically, public debt was often monetized which resulted in high inflation. There are also worries whether the government will be able to meet its debt payments, or it will be forced to cut its spending or increase taxes, which could hamper economic growth.
The best example of the impact of federal debt on the gold market may be the U.S. in the 2000s. President Bush created a twin deficit and significantly deteriorated the fiscal position of the country (as one can see in the chart below), which erased the investors’ faith in the greenback and triggered a rally in gold, confirming that it may be a hedge against irresponsible fiscal policies.
Chart 1: Gold price (green line, left axis, PM fix) and U.S. public debt to GDP (red line, right axis, in %) from 1999 to 2011.
The above chart supports the opinion that the federal debt is a driver of the price of gold. However, the time horizon was cherry-picked. In the long- run, there is no one-to-one positive correlation between the price of gold and the U.S. public debt, as the chart below shows.
Chart 2: Gold price (green line, left axis, PM fix) and the U.S. public debt to GDP (red line, right axis, in %) from 1968 to 2017.
Although there were periods when the price of gold and public debt moved in tandem, there were even longer periods where they did not. A lot depends on the broader macroeconomic context, the stance of monetary policy, the level of inflation and real interest rates, etc.
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