They will Sacrifice Your Savings
How the Governments and Central Bankers will use Financial Repression and Inflation to pay for their games.
A lot of this is based on the work of Russell Napier. I suggest you read his writings, including his book, The Asian Financial Crisis 1995-98: Birth of the Age of Debt.
Block 0: Implosion of Money
In Venezuela, cash is quite literally trash. So the residents turn it into purses and other forms of artwork, ironically assigning it some practical value. Below is not a chart of LUNA or UST, this is a real currency (the Bolivar,) that a real oil-producing nation uses. Recently a million to one conversion was made, but nothing has changed, every one USD is worth approximately 4.1M Venezuelan Bolivar. In 2019, YoY change in inflation was an astounding ~11,000,000%.
This is not the first time in history money has imploded as a result of asinine policies led by reckless politicians and central bankers. Take a quick look at the history of Argentina, Germany, Turkey, Iran, South Sudan, or Zimbabwe, all of these places have felt, intimately, the devastating effects of ineffectual policies. What we are now seeing is history repeating in slow motion. Over the last two years, the amount of USD circulating globally has increased by 40%. How is it possible then that we have yet to meet the same fate as the countries listed above? Why are we not making a purse out of folded 20’s and hawking it to Chinese tourists? In short, the world needs a seemingly endless amount of dollars, for now.
Recently we have seen radical changes to the structure of our economy. The current regime of “print to fix” enacted by lawmakers and Central Bankers came about as a forced response to nuanced problems, primarily Covid. Being reactionary is in itself part of the problem, despite what they say, Central Bankers don’t have all the answers. And their particular flavor of monetary policy only serves to make problems worse. The point here is that Central Bankers are largely impotent to the powerful market forces at play. As George Selgin argues in his book (Money Free and Un-Free) Central banks themselves are in practice a destabilizing entity, not a stabilizing one.
Over the course of this piece, we will show how the Fed uses rate hikes to control inflation they themselves set in motion And how it seems obvious too much emphasis has been placed on rate changes by investment professionals.
We also want to bring into question the central banker’s capacity to hike much higher with the current levels of debt now plaguing our economy. We have slipped into a vastly different geopolitical environment, one of unsustainable debt, shifting global power, and crises (not reason) driven policymaking. The dim and shapeless monsters of notions that have stood at a distance behind opaque curtains have quietly stepped into place like colossal titans. We must question how this all came about, what comes next, and how to prepare?
Block 1: Our Problem
To understand what’s coming we first must understand what happened. Brenton Woods circa 1944 was the agreement that instituted the gold standard. Bretton Woods II took place in ‘71. It was then that the Nixon administration realized there wasn’t enough gold to fully back the number of physical dollars needed to sustain global markets. Which led to them effectively closing the gold window. This series of events eventually led to the Petrodollar standard. Dollars were now de facto backed by oil.
We have written about this in the past so we will refrain from rehashing what’s been said ad nauseum. What’s important to understand is that the effects of the Petrodollar standard are deflationary in nature because there is no longer a hard asset backing paper. Couple that with a technological revolution and you get raging deflation. This deflationary regime spawned by that decision made in ‘71 was only exacerbated when China tied its currency to the US dollar in 1994.
(To briefly explain, China does not have a floating peg like most advanced economies, they manipulated their currency so that it followed the dollar roughly 8:1, over recent years they have allowed the Yuan to appreciate, but it remains pegged all the same.)
Deflation
It’s believed that deflation is the death knell for an economy, and like all good Keynesian heroes of old, Central Bankers have sworn to defeat this evil whatever the cost. Remember the famous “Whatever it Takes Speech” with the then President of the ECB.
“Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” - Mario Draghi 2012
But is deflation actually evil? And is stamping it out to the benefit of the people, or the ruling class? It’s interesting to note that from the early 1800’s to 1860 prices dropped drastically due to the rise of industrial mechanization, yet output grew consistently until the Civil War. Between 1873 and 1879 prices dropped roughly 3% every year, yet growth was up 7% in that same period.
Oddly enough, it wasn’t until the forming of a centralized bank that we began to associate deflation with “bad”. The innovative technological environment that we all now exist within can only be described as a deflationary beast that is perpetually hungry. This of course means Central Bankers are fighting an uphill battle to consistently achieve their mandate of 2% inflation per year.
As all of you probably know, the way Central Bankers have been able to achieve perpetual inflation is through the manipulation of the Federal Funds Rate. The FFR is the interest rate at which banks and other depository institutions lend money to each other, usually on an overnight basis. The Fed increases and decreases this rate to deter or inspire borrowing. In other words, low-interest rates mean high debt, why? When people and institutions can borrow money for almost free, they inevitably will borrow to the hilt and invest the capital in some yield-bearing asset, and why not? But what happens with the rate hits zero, like now?
Historically, when the Fed lowers the rate, it’s like putting an AED on the chest of a collapsing economy. However, in ‘08 the Fed discovered that low rates weren’t enough, so they came up with a hammer and used it like a scalpel, the hammer’s name was QE, or Quantitative Easing.
“Quantitative easing is a monetary policy whereby a central bank purchases predetermined amounts of government bonds or other financial assets in order to inject money into the economy to expand economic activity.”
Again, QE leads to a particular type of money and environment that rewards borrowers. Meaning debt continues to climb in relation to output (GDP.) The debt to GDP by the time Covid hit was already at dangerously elevated levels, the decisions made during the Covid crisis only served to fuel an already dire problem.
During the crises, Central Bank’s pulled their usual playbook, but despite the massive stimulus, low rates, and QE, commercial banks refused to lend for fear of taking on too much risk in uncertain times. This spectacular failure to increase broad money supply in hopes of stimulating a death-spiraling economy only served to show how dilatory Central Bankers are. Their actions, did, however, serve to increase debt exponentially. Great work team!
This brings us to our crux. High levels of debt coupled with low levels of output inevitably lead to the default.
"Over the past two centuries, 51 out of 52 countries that reached sovereign debt levels of 130% of GDP ended up "defaulting" [within 0 to 15 years], either through devaluation, inflation, restructuring, or outright nominal default." – Lynn Alden
So you see, debt to GDP level above 130% historically means disaster, the States have managed to circumvent this fate by the sheer fortune of being the global reserve currency, but what happens if that’s no longer the case? Russia is selling energy in Rubles and Bitcoin, while offloading USD from their balance sheets, and others are following suit. This can lead to less demand for dollars.
Put simply, the US needs the world to use dollars, otherwise, it wont have the cash flow to service its debts. The fewer dollars needed in the world the more daunting the debt becomes, and the more likely we are to see default and depression.
Block 2: Their Solution
At this point, you might ask, how do we get our astronomical debt under control? Glad you asked, there are actually a few answers.
As Russell Napier puts it, the most beautiful way would be high nominal GDP growth, but with current demographics, this seems unlikely. So let’s list our options below.
Options 1: Austerity
Austerity is what most of us were told was the responsible way of governing one’s own finances. It would mean the government ceases to borrow and instead pays down its debts. However, the best way to do this is by scaling back social policies. In today’s environment, cutting social policies would warrant a guillotine from the mob. (This was tried after the financial crisis to a certain extent with little success.)
Option 2: Default
Default has also been tried before and failed. The United States must not be allowed to default on its obligations? The entire global economy is based on the premise that US Debt is “risk-free.” If default were to occur, the entire global financial system would be at risk. Not to sound too doomy but default leads to mass starvation, war, real end of times stuff.
“Default produces crushing contraction in your economy. Remember the worst part of the financial crisis was triggered by the Lehman brothers default, 606B default cascaded through the system.” – Russell Napier
Option 3: Hyperinflation
Hyperinflation will get rid of the debt burden quickly. The long and short of it is that your debt becomes worthless because the dollars themselves are devaluing. The problem here is of course the proletariat. Once people can no longer afford bread they start attending the meetings like the ones they had in France at the Saint-Honoré Monastery of the Jacobins, circa 1789.
Option 4: Real Growth
As we discussed previously another way is high real growth. Which, for all the reasons already mentioned seems unlikely. (Demographics, shifting global economies, political interests etc.)
Option 5: Financial Repression (FR)
“Financial repression is a term that describes measures by which governments channel funds from the private sector to themselves as a form of debt reduction. The overall policy actions result in the government being able to borrow at extremely low-interest rates, obtaining low-cost funding for government expenditures.” – Google
TLDR; The Government forces savers into government bonds instead of investing in other vehicles so they can borrow money cheaply and keep kicking the can down the road.
Practically the tools of financial repression could look like, taxes, price controls, capital controls, regulation, and even rent controls. For example, imagine the government heavily taxes all investments except government debt, this highly incentivizes investors to park cash in one place and not another.
Investments these days are mostly government-sanctioned and tend to be ones and zeros on a screen, not hard assets, so it’s actually quite easy for the Government to mandate that a certain percentage of Public Pension plans need to be allocated to Government coffers. The last and most aggressive weapon of FR would be the manipulation of stocks themselves, which seems like an unlikely scenario, but not impossible.
The goal of these policies is ultimately aimed at forcing savers to invest in fixed interest securities at a level of interest below inflation. If you can achieve this, you can de-lever your economy. Over the last 10 years, you didn’t need to force savers to own government bonds because inflation was at a very low level, but now it seems to be a necessity.
To those of you still skeptical, we would say, all of this is absolutely a re-run of history (more European history than American,) lest we not forget President Nixon brought in price and wage controls.
Our point is that three of the options set out above won’t be chosen for political reasons and one is very unlikely to happen naturally. Which leaves the more subtle solution, financial repression.
Block 3: Endgame
Financial repression - is at this point- a necessity if you are the US Government and are in dire need of cash to pay off your monolithic debt. But is it enough? Why not compound your efforts by using inflation to devalue the debt at the same time? As we mentioned earlier, in the last two years, the total amount of dollars in the world has increased by 40%. We acknowledge inflation can be fueled by multiple factors including supply chains, and demographics. But it would be irresponsible to deny that the root cause remains the creation of money.
The perversion of money corrupts every market and transaction downstream, yet the Fed continued to paint itself into a corner by kowtowing to uninformed and misguided political whims. They are stuck in between the need to create money, while at the same time stamping out the expectation of inflation. Quite the quandary.
How will they achieve this? We mentioned before that the Fed failed spectacularly at increasing broad money supply when Covid first hit, so what changed and how did they eventually succeed? Central Bankers figured out that by backstopping loans they could incentivize commercial banks to disseminate cash to main street. But they also learned that by doing this they could allocate credit with surgical precision and boost – in their view - acceptable industries. In other words, they could direct capital to industrials instead of tech. In our opinion, this will be the final blow to our free-market economy.
Controlling credit has a secondary use case. The Government realized that controlling the flow of credit with precision is an incredibly powerful political weapon for obvious reasons. (Fun fact: This is exactly how the Japanese stimulated post WW2.)
So the Fed and the Government won’t stop creating money, but we still have that pesky inflation problem. It should be obvious that when inflation and debt are incredibly high you run the risk that recessions turn into depressions. Depressions historically lead to social and political dislocation and potentially even World Wars. So how do they achieve their goals of destroying debt via inflation while at the same time keeping the public calm?
The answer, use bankers to fix “emergencies” via the creation of money. This accomplishes 3 goals,
1. The creation of money. (Devalue debt)
2. Collecting political clout by funding socially acceptable initiatives.
3. Control the inflation narrative. (Stop buying bonds/MBS’s, and instead spend billions on “green” policies, 25% raises for congress, paying Lockheed, etc.)
What kind of emergencies would allow politicians an excuse to push credit where they need it to go?
If you cant think of any, I’ll name a few.
Infrastructure
National Security
Health Emergency
Covid Crisis
Inequality Emergency
Cold War with China
Rise of Labor price
Environmental Emergency
War in Ukraine
Energy Crisis
Famine
We’re not saying some of these things aren’t actual emergencies, but the current policies being put forth in their name are -in some cases- futile and in fact harmful. Doomberg has written insightful articles surrounding this crime against humanity which we recommend everyone read (Diesel for Dinner.)
Block 4: Double Edge Sword
We hope it’s evident by now that using bankers to “fix” emergencies will only result in an increase in bank credit, which leads to an increase in money supply, and subsequently an increase in inflation. The policies put forth will be espoused as a necessity, and they are, but the necessity has to do with economics, not the environment or the betterment of the society at large.
The actions being taken serve as a double edge sword, destruction of debt, and the ever politically powerful strategy of virtue signaling. Make no mistake, we will see elevated levels of inflation -by design- for the next decade. And if the game continues on in this way, who do you think is forced to hold the bag full of negative-yielding debt?
Inflation, Financial repression, and Famine are no longer specters looming in the distance. They are here, and you are expected to sacrifice your savings in the name of the king.