In its battle against inflation, the Federal Reserve Bank (Fed) unanimously raised the US interest rate by another 0.25% up to 5.5% on July 26th. This marked the 11th increase since March 2022 when the rate was near zero at 0.25%. Now, the US interest rate stands at the highest level in 22 years.

Dumb Money vs. Smart Money, as of July 28, 2023. Source: Sentimentrader.

While Fed Chairman Powell left the door open for further rate hikes, the US stock markets had been pricing in the narrative of a soft landing ever since the release of the weaker-than-expected US inflation report on July 12th. The sentiment among the so-called “Dumb Money” had become extremely optimistic, while the confidence of the contrarian “Smart Money” was notably pessimistic.

With such an exaggerated sentiment picture, alarm bells must be ringing. However, thus far, there had not been any trigger for a correction. Not surprisingly, however, since the beginning of the week, there has been a first pullback in the stock markets.

In the gold market on the other side, the significantly higher interest rates, along with the continued hawkish statements from Fed Chairman Powell, the reduction in liquidity due to balance sheet reductions, and a stronger US dollar, have all left their marks. Nevertheless, it is worth acknowledging that the gold price has shown relative strength despite all those headwinds.

USA will soon have to allocate over USD 1 trillion annually just for interest payments!

USA Total Debt, as of August 2nd, 2023. Source: Holger Zschäpitz.

On Tuesday evening, the rating agency Fitch downgraded the USA’s long-term foreign currency and issuer default rating from AAA to AA+. This move was long overdue, given the “deteriorating fiscal position, growing state indebtedness, and erosion of US government governance.” While the rating agency S&P (formerly Standard & Poor’s Corporation) has already rated the USA with AA+ since the summer of 2011, Fitch and Moody’s had maintained the “Triple-A” rating until now.

As a result, the USA had been overall rated AAA. However, this is no longer the case, and the downgrade of the US credit rating is likely to lead to bond portfolio reallocations and should also put pressure on the US dollar in the short- to medium-term.

In an initial response, US Treasury Secretary Yellen expressed strong disagreement with Fitch’s decision. She deemed the downgrade of the US credit rating as “arbitrary” and “outdated,” claiming that the loss of the highest credit rating was based on outdated data. In truth, she is correct, as the annual US interest payments have now reached not USD 500 billion but are on the verge of surpassing the historic mark of USD 1 trillion for the first time in US history.

Since 2020, these payments have nearly doubled, with debts not being reduced or repaid, but rather new bonds being issued to cover the debts. Soon, interest expenses will consume over 20% of the total revenues of the US government. In June 2023 alone, the USA spent over USD 70 billion on interest expenses, which is more than what was spent on education and veteran support combined. In the near future, these interest expenses will also exceed the national defense spending.

US interest rates increased by 2,100% in 14 months!

At the same time, Mrs. Yellen’s former employer, the Federal Reserve Bank (Fed), has increased interest rates dramatically by twenty-one times in the last 14 months, bringing it to 5.5%, the highest level since 2001. The last time interest rates were this high 22 years ago, the US debt stood at “only” USD 6 trillion. Today, however, the US debt amounts to around USD 31.5 trillion.

Smartly, Janet Yellen and her predecessors failed to take advantage of the thirteen-year low-interest rate phase to issue extremely long-term government bonds. In contrast, the Austrian Finance Minister, for example, increased a 100-year government bond three years ago at an interest rate of 0.85% up to EUR 5.8 billion. This has led to the Austrian taxpayer paying the lowest interest rates ever for these government debts.

Income tax revenues of US states & municipalities, as of August 2nd, 2023. Source: Tavi Costa.

On the other hand, US states and municipalities are currently experiencing the worst-ever recorded decline in their income tax revenues. In fact, it is the second-largest percentage decline year-on-year in history, surpassed only by the Great Depression of the 1930s. Federal tax revenues have also decreased again in the year-on-year comparison (-10%) and are now at a recessionary level. This is a clear indication of the ongoing fundamental deterioration of the US economy, which sharply contrasts with the still excessively high valuation of US stock markets.

US downgrade comes just three weeks before the BRICs meeting.

Overall, it only took a regional banking crisis with three bank failures and a near-default by the USA, necessitating an unlimited increase in deposit insurance, for the rating agency Fitch to recognize that the US debt situation has become unsustainable. This process is both unprecedented and absurd.

However, as known, the business model of rating agencies is highly susceptible to conflicts of interest, as the ratings are typically paid for by the issuers and not the creditors. The debtor, therefore, pays for the evaluation of their creditworthiness, and the higher the credit rating, the more favorable the refinancing terms. Due to this, the BRICs nations had announced their own alternative rating agency a year ago.

Now, the loss of the highest credit rating comes at an inconvenient time for the USA, just three weeks before the upcoming BRICs Nations meeting. Of course, the USA can always print US dollars, hence there is “zero probability of default”.  However, the downgrade, coupled with escalating interest expenses, will have a detrimental effect on the US dollar, as well as the increasing de-dollarization trend. The US dollar as a global reserve currency has never been as vulnerable as it is currently. As world-wide anti-dollar sentiments grow stronger, the USA has little to offer beyond its military power and its technology leadership.

The BRICs turn to gold.

In fact, after months of debates and negotiations over various currency and commodity baskets, it appears that a consortium led by Russia and China has agreed to use gold as the foundation for a planned new international monetary system. This system is intended to stand apart from the US dollar and the euro. This new initiative might be officially presented at the upcoming meeting of the heads of state and government from Brazil, Russia, India, and China on August 22nd in Johannesburg. For the US dollar and, conversely, the gold price, this could bring about a complete reassessment.

The power struggle between China on one side and the USA on the other has been brewing for many years and across multiple fronts. It may finally culminate in a showdown this August. Therefore, the gold price is likely to begin factoring in the escalating duel over the trade and reserve currency soon. The coming weeks promise to be exciting and explosive!

And even if the BRICs conference were to pass without an openly spoken challenge, the USA will have to weaken its currency further through the printing press in the medium term to just keep up with their interest payments. The same applies to the Eurozone and the euro, of course.

As a concerned citizen, one must therefore increasingly question why taxes are required when the government can simply print currency?

Conclusion: Gold – Summer rally and power showdown in August