Be scared when US Fed chair says “we don’t really know” what will happen with tightening policies

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Central Banks around the world will continue to increase interest rates as part of their policies to end the inflationary consequences of their own expansionary monetary policies in recent years.

These policies feed into rate increases for all forms of debt and a restriction on new lending. As a consequence, stock markets are crashing, property prices are being hit, government and corporate bond prices are falling, and new investment is collapsing.

A generalised economic recession across the capitalist world is an inevitability. Most Central Banks are officially predicting just that and simply promising to try and soften the blow.

But to beat inflation the Central Banks also have to start withdrawing the trillions of dollars they have created since the 2008 recession. The US Fed’s balance sheet, for example, has increased from $1 trillion to $9 trillion since then.

Asked at a press conference on May 1 about the effect that balance sheet reduction might have on monetary policy, Powell replied: “In terms of the effect… I would just stress how uncertain the effect is of shrinking the balance sheet. You know, we run these models and everyone does in this field and make estimates… And you know, these are very uncertain. I cannot really be any clearer.… We don’t really know.”

This is an incredible admission from the supposed superstars of capitalist economic thinking. Central Banks worldwide have been invested with a mystique of being virtually infallible masters of the universe.

What we do know is that each previous time the US Fed has tried to reverse course on money printing the money markets essentially froze and no one was willing to lend to anyone else. To prevent a broader collapse money printing was resumed.

I explained this in more detail in a December 2020 blog headed “Printing money to save the power and wealth of the 1% is just stupid”.

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However, we now have the need for the system to crush inflation which means that this time the Central Banks will have to sit by and watch as a broader collapse unfolds.  This will begin at the weakest links in the system, impacting the most heavily indebted first. All debtors – personal, corporate, and countries are at risk as interest rates rise relentlessly.

Simply the promise to increase rates from below zero to above zero by the European Central Bank has created a crisis in Italian government debt which immediately began to be targetted by the “Bond Vigilantes”.

I’ll quote a bit from the payrolled article from the Financial Times reprinted in the NZ Herald on June 15 headed Surging borrowing costs take Italy ‘close to the danger zone’:

Investors are questioning how far Italy’s borrowing costs can rise before they rip a hole through the heavily-indebted country’s economy, as a sell-off intensifies across eurozone bond markets.

Yields have shot higher in the bloc since the European Central Bank last week signalled an end to the stimulus measures it ramped up at the onset of the coronavirus pandemic. ECB president Christine Lagarde confirmed plans to withdraw a large-scale bond-buying programme and to initiate interest rate rises next month to tackle record levels of inflation.

In turn, Italy has found itself in the market’s crosshairs, because of its need to refinance a borrowing load of around 150 per cent of gross domestic product. Investors are dusting off calculations from the eurozone debt crisis a decade ago as they try to understand when the rise in yields could start to imperil finances for the Italian government as well as for companies and households.

“You can tell things are getting bad because people are starting to publish papers on Italian solvency again,” said Mike Riddell, a bond fund manager at Allianz Global Investors. “The market isn’t panicking yet, but all this focus on Italy is starting to feel a little like 2011,” he added. Back then, worries over Italian debt sustainability pushed Italy’s 10-year yield to a record high of more than 7 per cent. It touched an eight-year high of 4.06 per cent on Tuesday.

The spread between Italian and German 10-year yields peaked at 5 percentage points at the height of the debt crisis a decade ago. Andrew Kenningham, an economist at Capital Economics, said he did not think the ECB would let it get that high, predicting it would intervene once it reached 3.5 percentage points.

The recently extended average maturity of Italy’s outstanding debt, at over seven years, means the recent rise in yields will feed through only gradually to the country’s average interest cost, according to analysis by Goldman Sachs. However, seven-year borrowing rates have already blown past 2.75 per cent, the maximum level at which Rome’s debt load would stabilise, according to the bank. Italy’s seven-year debt traded at a yield of 3.79 per cent on Tuesday.

With prime minister Mario Draghi’s market-friendly government facing elections next year, any political instability “could well end up being a catalyst for renewed concerns about debt sustainability”, Goldman Sachs said.

Investors are also watching the gap between Italian and German borrowing costs — the so-called spread — which has widened to 2.4 percentage points, from around 2 percentage points before last week’s ECB meeting.

Failure to adopt policies to break inflation will simply lead to additional negative consequences as currencies decline in value. The Japanese yen has declined 15% against the dollar because they have resisted the end of easy money policies.

The central bank has pledged to fight so-called “fragmentation” of the eurozone financial system, but investors were unnerved by the lack of detail last Thursday on a new “instrument” to keep a lid on spreads.

Fund managers like Riddell who are betting against Italian bonds believe Italy’s spread has not yet reached levels that would prompt the ECB to intervene in markets. “The ECB had the opportunity to be more dovish and they turned it down,” said Riddell. “It’s almost an invitation to the market to cause more stress.”

Yields surged higher still on Tuesday after Dutch central bank president Klaas Knot told Le Monde that the ECB would not be limited to a half-point rate rise in September — opening the door to a 0.75 percentage point move.

“We are getting close to the danger zone,” said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, adding that the ease of trading Italian debt has deteriorated somewhat.

“I understand why the ECB is reluctant to move,” said Ducrozet. “But . . . if bond yields passed the pain threshold, the re-pricing might become self-fulfilling and the ECB would be unable to stop it unless they step in massively.”

As well as the longer maturity profile on its national debt, Rome is also benefiting from more than €210 billion ($351.7b) of grants and cheap loans from the EU’s Next Generation recovery fund.

But the ECB worries about a disproportionate rise in Italian borrowing costs, not only because of government debt sustainability, but also because they act as a floor for the overall financing costs for companies and households. In the first four months of this year, average Italian mortgage rates rose from 1.4 per cent to 1.83 per cent, a three-year high, according to the ECB.

The Italian central bank said the amount of medium- and long-term debt the country has to refinance will increase from €222b this year to €254b next year, which combined with drastically lower purchases by the ECB is likely to increase upward pressure on yields.

Rome may have to rely more heavily on Italian financial institutions to buy more of its debt, which could reignite concern about the banks’ vast domestic sovereign debt exposure.

At the end of April, Italian banks held over €423b of domestic government debt securities and €262b of loans to their government, only slightly below their peak levels in 2015 following the eurozone debt crisis, according to ECB data.

If this increases further — and foreign investors were already reducing their exposure to Italian sovereign bonds last year — it could reignite fears about a vicious circle between private sector lenders and governments weakening each other, and ultimately threatening the existence of the single currency zone.

“Eurozone banks are in better shape in terms of capitalisation and stock of non-performing assets,” said Lorenzo Codogno, a former chief economist at the Italian treasury. “Yet, they still have a sizeable position in domestic government bonds in many countries. The sovereign-banks doom loop can still be triggered.”

Italy is trapped in the Eurozone without its own currency so can’t adopt monetary policies independently. The European Central Bank has no choice but to keep raising rates and reducing its own balance sheet (which includes Italian government bonds) to crush inflation. It can’t protect the Italian Bond market at the same time. A crisis is inevitable for Italy and other more indebted nations.

Working people need our own solutions to the capitalist crisis that is coming. Private ownership of wealth is the ultimate source of the problem. The owners of wealth (financial, industrial and land) are only interested in maximising their profits and wealth at the expense of working people and the planet. Democratic ownership and control of wealth in all its forms is the only path out of the crisis we will be facing. We can then use that control to solve the world’s pressing problems, from climate change, the environment, housing, employment, welfare and education in a manner that meets the needs of the vast majority of humanity not the greed of the 1%.

24 COMMENTS

  1. Here is a proposed solution that is worse than the described problem. Just ask a North Korean or Cuban how they feel about ‘democratic’ ownership and control of their wealth.

    • Your imagined trope-fed version of Cuba s unsurprising, unremarkable, and totally inaccurate.

      I’ve been to Cuba. Spoken to many Cubans. They have many and different views, as many as NZers have about their own system, and the external factors that influence it.
      They’re also 10x happier than most NZers. Far less to worry about.

      • Yep for sure…but is happiness their natural demeanor? Would they be even happier if they controlled their own wealth? I note that 297 have just been sentenced to 5 and 25 years in prison after taking part in anti-government protests. Perhaps not so happy after all?

    • That MIGHT be a reasonable thought, HOWEVER given both those countries have tyhe equivalent of a modern day ‘siege’ it means you can NOT logically or intelligently make that connection.
      IT MAY be true, but it is FAR far from certain.
      Let’s see what happens after the immenent collapse of the USA empire and the subsequent new world reserve currency. Then we’ll get a more honest idea if your assumption is correct or not.
      I for one doubt it is true. When Govts ‘created money’ we had way less (relative to the times) financial problems than when the top 0.000000001% (i.e. a dozen or more people ish) were given the rights to do so.
      Just look at the ownership of the neither Federal, nor with any reserves bank.

      • Just a small point, people created money because they got sick of bartering fishes for necklaces. Some were better fishermen some were better artisans. I’m not saying money makes you happy, just look at Messers Heard and Depp for example However freedom does so more than compulsion. A quick scan of 20th century history will provide ample examples where collectivization of resources never worked – basically, because the hard worker gets the same as the lazy and inefficient and so there is no incentive to productivity.

    • North Korea is clearly autocratic as the unfortunate people living there are all to well aware.
      To insinuate Mike is advocating such a system sounds like a gNat politics 101.

      • So how does one achieve Mike’s “democratic ownership and control of wealth in all it’s forms” without autocratic compulsion? Autocracy and economic collectivism go together like hand and glove. BTW I haven’t voted Nat in over 20 years but thanks for the insinuation.

        • You achieve it democratically. People vote for it. I recommend https://www.democracyatwork.info as a good source to better explain this better than I can.

          Okay, so you voted for Bolger/Shipley/English or thereabouts. Thanks for being honest. I don’t need to ‘insinuate’ anything else.

  2. Indeed. There will be a global recession, it will greatly hurt New Zealanders- but this is an own-goal. It’s ‘our’ choice (as much as the creeps in the Beehive are ‘our’ people, anyway).

    NZ could do great as an autarky, or trading with real human nations like China, Iran, Venezuela, Russia. Instead, traitors in power tied us to the Ammurrican anchor.

    • John White we do a whole lot more trade with China than the US. Also I get that we have responded in a similar fashion to a number of other central banks, but I don’t think a Global recession is an own goal

    • Having spent a lot of time in Venezuela I can assure you it is a totally corrupt economic ‘basket case’ becoming worse by the day. No future trading there until the Chavistas are kicked out, which they surely will be in the not too distant future.

  3. Mike, good illustration of the issues.
    But they’re lying, they do know what will happen. They are crashlanding the system, a instructed, and the next step has already been delineated by their global financial masters.
    They will flood with credit, effectively dissolving cash, and forgive all debt. Effectively eliminating private ownership, with everything belonging to the global stakeholders of the common – that is the global corporate entities, with a unified structure of global government to protect their interests, and use centrally organised digital currency to reward/punish and control the masses (who survive).
    They have literally published all their plans, and like the “Covid all-in-this-together response”, the policies are flowing down through the global networks. Hence every western country working on digital passports and currency – not from the initiative from the people, but from far, far above.

    • no magician they’ll foreclose on individuals shift the assets to corporations and carry on, that’s how capitalism works and is intended to work, capital flows uphill, shit flows downhill, the funniest thing is the middleclass are fooled every time into thinking they are capitalists when they are the prey.

      and yes ‘digitisation’ of personal liquidity is a fuckin disaster waiting to happen either from malicious bank/govt actions or computer system failures….fully digitising money is a silly silly idea.

  4. “The owners of wealth (financial, industrial and land) are only interested in maximising their profits and wealth at the expense of working people and the planet.”
    That is not strictly true. We own and work the land, as whanau, hapu and iwi. Our objects are not profit, but precisely to provide for the basic human needs of our own and future generations.
    So the problem is with attitudes towards land and other forms of wealth, and it is not only the “1%” who have bad attitudes.
    Most of the 99% have been indoctrinated with the capitalist ideology and look to their “Kiwisaver”, “Sharesies” and “rental property” for financial salvation. They are the ones who will be “scared” by the prospect of global inflation and recession. Not us, and not the 1%.
    The solution? Regardless of where you sit in the scheme of things, stop treating land as a means to profit, stop participating in capitalist institutions like Kiwisaver, recognize that your only security is in the work of your hands, the love that you give to and receive from your hapori and ultimately the grace and mercy of Ihoa on nga mano.

  5. I don’t know if its private ownership of wealth or is private interests essentially controlling the government that is the problem? As has been said profit is privatised, losses are socialised.

    All these people wank on about the free market but the reality is its only free when it suits.

    How much of inflation is just pure price gouging? The problems are supposed to be supply side but I think if you look at things like oil production in the States there was reduced demand in a pandemic but supply now is actually pretty solid. There will probably be some ideas spread about moves to greener sources of energy having an impact on ability to supply but the numbers don’t support that.

  6. So this a worldwide economic recession, was it instigated by Jacinda? Asking for coward cabbage, Bob the last, Mike Hosking, Heather 2 + 3 Allan, et al.

  7. “Democratic ownership and control of wealth in all its forms is the only path out of the crisis we will be facing.”

    So Communism, in other words? Everything (literally) should be owned by a democratically elected state, which of course will have an elected (Dear) “Leader”? You really think that is the answer to the world’s woes? Maybe it would help if you define what you mean by “wealth”? But this solution on the face of it is set up to utterly fail in a rapid cascade to totalitarianism and at best ending in civil war and revolution.

    • no nitrium bearing in mind they weren’t actually ‘communist’ in the ussr/warsaw pact countries citizens had private bank accounts, savings, even a form of mortgages….so no not communism

      but, mongo don’t like = communist…is a tediously common rightard ‘talking point’

  8. Yes, Mike. Their modelling is not based on reality. The parameters are all assumptions.
    For example; in NZ. The inflation rate guesstimated by economists is based within the 1%-3% range limit(s).
    So when shit gets reels, and inflation kicks in outside of that range. Their model is therefore made redundant.
    Does not compute so then they come up with word salads to explain that the real-world inflation is wrong!

    Economists and politicians have a lot in common.

  9. True radicals should raise their fists in celebration, as a ‘brave new future’ for humanity & environmental reprieve will only be possible when our capitalist, consume driven, virtue signaling, western hegemony world bites the dust.

    • Soviet Russia and China haven’t had a great record on pollution and environmentalism. May be a communist utopia would….

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