We Are Argentina Now

We Are Argentina Now. By the Z-Man.

The Federal Reserve and European Central Bank have for a long time now been wrestling with a problem that is truly novel. They find themselves in an interest rate trap, which means they need to restore borrowing rates to something close to the historic norm, but doing so puts the global banking system at risk.

Most governments and mortgage holders cannot afford to pay the interest bills if interest rates return to historic norms, let alone the 20% rate required to stop inflation in 1979.

The political class is just as hooked on cheap money as the bankers, so their is no appetite for a Paul Volker like approach to solving the money problem in the West.

For a long time, the problems were abstract. Everyone knew that near zero interest rates would one day create big problems, but in the here and now they made all of the important people happy. The reckless and insane response to Covid by Western ruling classes moved the problem into the domain of reality. Massive spending by government put enormous amounts of cash into the hands of regular people, not just the bankers, and those regular people started spending it. …

For the last year, the Fed and ECB have been facing a problem. There is far too much money in the system and the demand for their money is in decline globally, which means they have to remove money from the system. They tried to ignore the problem by spinning yarns about inflation being transitory, but rocket high food bills made that story impossible to maintain. The politicians demanded the Fed “fix” the economy for them, so the Fed started to raise rates.

That is what brings us back to the interest rate trap. The entire Western banking system depends on exclusive access to cheap money….

Not just the banking system, but the modern welfare state and bloated bureaucracy. It is only the tide of newly money manufactured money, and the taxes on profits from rapidly rising asset prices, that has allowed government to get too big.

Over the weekend, the Fed with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank announced a global bailout of the Western banking system. They are offering unlimited cash in exchange for the illiquid assets on the bank’s books. The reason they did this is they know that every bank in the West has the same problem as Credit Suisse. That is their liabilities outweigh their assets so they are effectively broke.

Of course, you cannot fight inflation while showering the system with cash, which means the effort to rein in inflation has come to an end. The Fed will try to limit the swapping of bad assets for cash by substituting treasuries, but this sort of legerdemain is just so they can continue the game of make believe. High inflation is now the new normal in the West because it is impossible to raise rates.

The West has turned itself into Argentina through bad policy and worse politics.

New wave of inflation coming up. Redux?

Inflation in the 1970s came in three waves. This time around, many cannot afford the high interest rates that will be required to stop inflation, so the ending might be different. I see that bitcoin and gold did quite well in the last few weeks.

Btw, one response to the crisis of 2008 was that the banks (often) no longer have to value their assets at current market value, for the purpose of determining whether or not their assets are larger than their liabilities and thus whether they can continue operating.

For example, 10 year treasury bonds bought for $1m when overnight interest rates were 0% might only sell for $700k now that interest rates are 4%, but the bank continues to value them at $1m.

Suspension of the mark-to-market rule means that many banks that would have gone bankrupt in days gone by are now considered viable.