Pandemic, massive debt and gold

In our previous article, we emphasized the link between the current coronavirus pandemic and how this is likely to translate into an increase in public debt in many countries. We also emphasize that gold is likely to benefit from this situation. In this analysis, we will complement the above by showing you how much debt is likely to increase in selected countries.

Let’s start with Italy, whose economic fundamentals have already been poor: here we mean a fragile banking system, stagnant growth, and high public debt (see chart below). Now, as the European country hardest hit by the virus, with the highest number of cases and deaths, and the lockdown of its economy, Italy will enter a severe recession (the economy is expected to contract by at least 5 percent), while Public debt will increase from 135 to more than 140 percent of GDP, or even more; As a reminder, Italy’s public debt rose more than a few percentage points in the single year of 2009 (from 106.5 to 116.9 percent of GDP).

Other southern countries will also face the resurgence of the sovereign debt crisis. This time, Greece’s debt-to-GDP ratio starts at more than 180 percent, compared to 146 percent in 2010; Spain at 95 percent vs. 60 percent; Portugal at 122 percent vs. 96 percent; and France 98 percent vs. 85 percent. And private debts have also increased in recent years!

The United States is less indebted and not as affected by COVID-19 (at least so far), but its economy is also expected to contract in 2020. The combination of lower GDP and tax revenue with higher public spending will increase the deficit and federal debt from just over $ 23 trillion, or 107 percent of GDP, in 2019 to nearly $ 26 trillion, or more than 120 percent of GDP, in 2020.

Now, it means we have a serious debt problem. How could all these countries pay off all their debts? Well, they could raise taxes. It could happen in the United States if a Democrat takes over the White House. However, taxes are already high and unpopular. Thus, governments could also accelerate economic growth, but this is highly unlikely given the pre-pandemic trends and accelerated response. And if taxes go up, growth will not accelerate for sure. So the only option left, and historically more likely, is to inflate debt. Financial repression with the corral of mandatory investments in “safe” assets that are guaranteed not to keep up with real or massaged inflation data.

With higher inflation, the real value of public debt will be lower. And central banks have already enthusiastically started buying government bonds with newly created reserves. It means that one of the important implications of the current pandemic and the next policy response will be higher inflation. Perhaps not immediately, as the negative demand shock will create some deflationary pressure (although the negative supply shock creates inflationary pressure), but we must not neglect the threat of inflation. It only means one thing: when the dust settles and investors realize what is happening, they will turn to the ultimate hedge against inflation: gold.

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