It started in the 1600’s, when religious moratoriums on charging interest and creating money out of thin air were abandoned in Europe, by sovereigns desperate to raise more money to fight wars. Now we are fast approaching the logical endpoint of the banking game. There is a limit to the easiness of money, and we are now almost there.
The truth is, the solvency of nearly every developed nation on earth is contingent on interest rates that remain in the sub-basement of history — aka, record lows and around zero percent. This is only possible if central banks maintain complete domination of free-market forces and keep their hydraulic presses down on yields.
Let’s be honest, without the backstop of these state-owned entities, solvency and inflation concerns would combine to force yields much higher. In the case of the US, with CPI inflation at 6.8% and a national debt-to-income ratio above 725%, it would be impossible for a 10-year Treasury bond to yield just 1.4% without the heavy hand of the Federal Reserve. The point here is that the US has immense solvency and inflation problem now, yet still enjoys record-low borrowing costs thanks to the Fed.
However, this function is now changing. A central bank can usually usurp the free market regarding its sovereign borrowing costs as long as both solvency and inflation concerns are quiescent. For example, the Fed has yet to truly exit its yield curve suppression programs, which have existed for the better part of the last two decades, because consumer price inflation was not an issue. This is true even though our Nation’s debt to GDP ratio is higher today than any time since WWII.
Up until this point, that growing trend towards insolvency has been veiled thanks to the central bank’s interventions. But the resurgence of inflation, in conjunction with that humongous debt burden, has become extremely problematic.
In the absence of inflation, central banks have been able to print enough money to ameliorate recessions, bear markets, real estate debacles, and solvency concerns — such as the European debt crisis circa 2012. Where Bond yields in the southern periphery soared to 40% before European Central Bank chief Mario Draghi promised to monetize the debt issues away. Again, he could only accomplish that because inflation was not a concern a decade ago in the Eurozone.
Turning back to the US, the next recession, which is likely to occur in ’22, will cause solvency concerns to spike as revenue collapses and the National Debt-to-Federal-income ratio soars. However, this time around the Fed’s ability to monetize away collapsing asset prices and crumbling economic growth will be fettered by an inflation rate that is already many times greater than it is comfortable with.
Interest rates cannot go any lower. Soon they will have to choose: depression or inflation?
That leaves the Fed and Treasury with a dangerous dilemma: allow asset prices and the economy to implode, which will certainly fix the inflation problem; but will most likely lead to a depression. Or, try and pull the economy and assets higher by once again borrowing and printing multiple trillions of dollars, which will send the rate of inflation skyrocketing from its 40-year high.
For obvious political reasons, they will choose inflation rather than depression (they chose depression in 1930).
That will risk destroying confidence in the USD and any faith that remains in the bond market. Therefore, the stock market and economy would collapse anyway as inexorably rising inflation pulls yields on sovereign, municipal and corporate bonds ever higher.
Wall Street’s perma-bulls will never admit that the Fed’s Put has now expired. Of course, the Powell Pivot will indeed happen once again as he continues to meander between hawkish and dovish depending on the lagging economic data he receives. But his next pivot back to an uber dove will only occur ex-post the Great Reconciliation of Asset Prices. This is why a buy-and-hold strategy no longer works and why identifying inflation and deflation cycles has become so critical.
We are currently in a booming economy. But the boom is largely based on the recent money printing, and it will turn to bust soon — probably sometime in H1 2022. Then inflation and unemployment will set in, and the fateful decision to rely on the printing press will be made. The end is nigh! Sort of.