In September, the president of the Dutch central bank wrote what may have been the most remarkable letter of his career: it said that the ECB’s interest rate hikes will lead to losses for De Nederlandsche Bank (DNB) for the first time since 1932. Several countries throughout the eurozone are facing a similar problem. To absorb the losses of their central banks, European taxpayers risk having to pay tens or even hundreds of billions of euros a year. Meanwhile private banks get that same amount of money without having to do anything in return. The ECB now stands ready to make a crucial policy decision to determine whether billions in taxpayer money will again flow to the banking sector.
On 20th September 2022, the board of the Nationale Bank van België (NBB) went into a panic. The Belgian central bank is owned half by the state and half by private shareholders. Unlike most other eurozone central banks, NBB’s shares are traded on the Euronext stock exchange in Brussels. The central bank therefore has a market value and that value suddenly collapsed.
The next day, pending a press release by representatives of the Belgian central bank, trading in NBB shares was temporarily suspended. Once trading resumed, NBB shares dropped even further in value: in just a few days, the share price plummeted from 1,600 to 860 euro.
The NNB press release made it clear in the very first sentence what had caused the sudden drop in share price: ‘The Nationale Bank van België took note of the letter written by Mr Klaas Knot, President of De Nederlandsche Bank, to Mrs Sigrid Kaag, Dutch Minister of Finance, with the subject heading “letter regarding DNB’s capital position”, which was published yesterday on the DNB website.’
It was not the Belgian central bank, but its Dutch counterpart which had caused the panic.
What had happened? On September 9th, the president of De Nederlandsche Bank, Klaas Knot, sent a letter to the Dutch Minister of Finance, Sigrid Kaag. On September 20th, DNB published the letter on its website. Its news on the monetary situation in the eurozone was so explosive that it shocked the Belgian central bank’s private shareholders. This resulted in them doing something that the state – which is the sole shareholder of the central bank in other euro countries – cannot do: they decided to sell off their shares.
Equity markets are ants compared to debt market elephants. From MN Gordon at economicprism.com:
Anyone with half a brain knew there would be hell to pay for locking down the economy and simultaneously printing and spewing out trillions of dollars of confetti money. The bill has finally come due.
Did you see the latest consumer price index (CPI) report?
According to the government bean counters consumer price inflation, as measured by the CPI, increased in September at an annual rate of 8.2 percent. While this is down slightly from several months ago, the year-over-year increase in prices is still near a 40-year high.
Stock market investors celebrated the news like mindless idiots. On Thursday, after the CPI report was released, the S&P 500 rallied more than 2.5 percent. Perhaps stock market investors were elated the CPI wasn’t even higher.
More important than the stock market is the debt market. Following the CPI release, Treasury yields spiked up. Bond investors know what’s coming. Specifically, more rate hikes from the Federal Reserve. They sold accordingly.
Because as interest rates rise, bond prices fall. This inverse relationship, which has been in existence since financial markets were invented, is wreaking havoc on debt investors. The value of the paper they’re holding is vaporizing in their hands.
Generally a central bank must try to raise interest rates higher than the prevailing interest rates for inflation to recede. That’s not what’s happening now. From Adam Mill at amgreatness.com:
No communist was ever as dedicated to economic suicide as the current class of idiots who rule us.
High inflation, overregulation, and a general sense that things are going in the wrong direction remind us of the late 1970s and early ’80s. But today the underlying problems that were responsible for our woes in that time are vastly worse. The coming reckoning for Washington’s insanely irresponsible monetary policy may dwarf the troubles from all recent recessions and periods of inflation.
The Federal Reserve has created a doom loop between the housing market and inflation. For years it has printed tens of billions of dollars each month to buy sketchy securities meant to subsidize the housing market and favor bond traders. This continues even now, in spite of inflation and a red-hot housing market. But the housing market has become dependent on unearned, newly printed money, and stopping the flow might cause a catastrophic correction. If it doesn’t stop, however, inflation will explode.
Let me walk you through some of the math.
Inflation closes the gap between money earned and money spent. Since the financial crisis of 2008, the Federal Reserve expanded M2 money supply from just under $8 trillion to around $22 trillion today. During that time GDP has increased from around $14.6 trillion to around $24.5 trillion today. We’ve gone from a ratio of one dollar chasing $2.20 in goods in services to an almost 1 to 1 ratio today. Inflation during the same period, according to the government, has eroded the dollar by a mere 33 percent.
The interesting thing is that no one at the Fed is trying to talk down those spikes in Treasury yields and mortgage rates. It shows that those yields are going where the Fed wants them to go, and that the Treasury market is coming around to the Fed’s rate-hike plan, and that those yields have a long ways to go, given that CPI inflation is 8.5%, a gigantic mess that has unfolded over the past 15 months, finally, after 12 years of money-printing.
The two-year Treasury yield spiked by 15 basis points today to 2.61%, the highest since January 2019. This has been a huge move in just seven months. When the two-year yield goes over 2.83%, it will be in territory not seen since 2007, as the Treasury market begins to price in the Fed’s coming policy action to crack down on inflation:
The bond bear market isn’t coming, it’s arrived, although it’s still early days. Interest rates are going much higher (and bond prices much lower). Buy that house now. From David Stockman at internationalman.com:
If you didn’t think the $70 trillion global bond market was a train-wreck waiting to happen, surely last week’s yield surge was a wake up call. From the 2.15% close one week earlier, the 10-year yield soared to a peak of 2.50% just after mid-day last Friday; and that 36 basis point gain was, in turn, the culmination of a stunning 200 basis point rise from the cyclical low point (0.51%) recorded during July 2020.
Needless to say, an economy staggering under the weight of $87 trillion in debt, representing a record 365% of GDP, can’t take much interest rate increase in any case. But when the Fed is drastically behind the curve and will be forced to hit the brakes hard (and unexpectedly) in coming months, you are talking about a recipe for financial carnage.
Once interest rates start moving up in earnest and credit begins to contract rather than expand, financial asset prices will fall and economies will contract. From Alasdair Macleod at goldmoney.com:
Leading central banks like to think that through careful interest rate management, they have tamed the economic cycles which lead to regular economic downturns. Instead, they have only managed to bury the evidence.
To appreciate the extent of their delusion one must understand the source of economic instability. In modern times it has always been driven by a cycle of bank credit. In this article the role of commercial banking in this regard is explained. The effect on non-financial economic sectors in the context of Hayek’s triangle under today’s currency regime is re-examined.
With cyclical variations in the economy buried under a tsunami of currency, market participants are oblivious to the dangers of a cyclical downturn in bank lending and the consequences that flow therefrom.
This article gives the problem its economic and monetary context. It concludes that the global banking system is horribly over-leveraged and, with empirical evidence as our guide, on the edge of a bank credit contraction of historic proportions, likely to undermine the entire fiat currency system.
Readers of articles that dissent from the mainstream media’s complacency might be aware that there are many zombie corporations which only exist courtesy of low interest rates or government support. The story often goes further. These are businesses loaded to the gunwales with unproductive debt, vulnerable to being swamped and sunk by higher interest rates. The extent of the problem is undoubtedly greater than most people think.
We have arrived at this point with economies around the globe cluttered with unproductive businesses which would otherwise have been cleared out in an unsuppressed interest rate environment. Schumpeter’s process of creative destruction would have done its work. Without it, the current situation presents enormous dangers now that with price inflation rising, interest rates will almost certainly increase in the coming months. Central banks appear to be conscious of this danger, given their evident reluctance to permit rates to rise, even fractionally. Rising interest rates also blow holes in their narrative, that they have succeeded in managing economic cycles out of existence.
Do central banks really control markets? Notwithstanding the fervent hopes of millions of investors, they don’t. From Tom Luongo at tomluongo.com:
The big story of the past couple of weeks is rising bond yields. Everyone’s talking about it. Everyone’s got a theory about it. Even me.
Why are yields rising?
What does rising yields mean?
But, to this point I’ve kept my mouth mostly shut on this, at least in public. I reserve my gut reactions for my Patrons, giving us the opportunity to work through ideas.
The financial press industry is obsessed with gut reactions because headlines are all that matters. It used to just be to sell newspapers or generate clicks. But now, with algorithmic trading, headlines are the market.
Central banks and politicians use their pulpit in real time to stick save markets or push them in whatever direction they want them to go — at least in the near term.
So do short-sellers, media personalities, and boiler room blowhards… but enough about Jim Cramer. The market is comprised of all of this confusing and contradictory information.
And it’s why we’re obsessed with the news flow and desperate to parse the purposefully opaque language of those with control over the money spigots.
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