Pandemic, massive debt and gold

In our previous article, we highlighted the link between the current coronavirus pandemic and how it could escalate into increasing public debt in many countries. We also stressed that gold is likely to benefit from this situation. In this analysis, we will complement the above by showing how much debt will increase in selected countries.

Let’s start with Italy, whose economic fundamentals are already bad: we mean a fragile banking system, stagnant growth and high public debt (see chart below). Now, as the European country most affected by the virus with the most deaths and economic blockades, Italy will enter a severe recession (the economy is expected to shrink by at least 5 percent) and public debt will increase from 135 to above 140 percent GDP, or even more – recall that Italy’s public debt in 2009 grew by more than a few percentage points (from 106.5 to 116.9 percent of GDP).

Other southern countries will also face a sovereign debt crisis. This time, Greece’s debt to GDP starts at more than 180 percent, up from 146 percent in 2010; Spain – 95 percent vs. 60 percent; Portugal – 122 percent vs. 96 percent; and France 98 percent vs. 85 percent. And private debt has also increased in recent years!

The U.S. is less indebted and less affected by COVID-19 (at least so far), but their economy is also projected to shrink in 2020. The combination of lower GDP and tax revenues with higher government spending will lead to deficits and federal debt of just over $ 23 trillion. dollars, or 107 percent of GDP, in 2019 to nearly 26 trillion. dollars, or more than 120 percent of GDP, in 2020.

Now that means we have a serious debt problem. How could all these countries repay all their debts? Well, they can increase taxes. In the US, this could happen if a Democrat takes over the White House. However, taxes are already high and unpopular. Thus, governments can also accelerate economic growth – but this is unlikely given the trend towards a pandemic and accelerating response. And if they increase taxes, growth will definitely not accelerate. Thus, the only option that remains – and is more likely from a historical point of view – is to increase debt. Financial repression is subject to mandatory investments in “safe” assets that are guaranteed to keep up with real or massive inflation data.

With higher inflation, the real cost of government debt will be lower. And central banks are willing to start buying government bonds with newly created reserves. This means that one of the important consequences of the current pandemic and subsequent policy measures will be higher inflation. Perhaps not immediately, as a negative demand shock will create some deflationary pressure (although a negative supply shock creates inflationary pressures), but the threat of inflation should not be neglected. This means only one thing: when the dust settles and investors realize what is happening, they will turn to the final inflationary barrier – gold.