Why Inflation Isn't Going Away.
As if supply chains and QE weren't enough, now bonds are staging a revolt....
I decided to write this article upon coming across yet another article that debates whether inflation is going to go away or not, even after all the evidence over the past months showing inflation is getting worse. The Federal Reserve still thinks it's transitory as per their predictions inflation will go down later in 2022 and 2023 - although the recent conference has probably shown to everyone Jerome Powell barely thinks at all; the ECB is in full blown denial and refuses to touch rates before 2024 because Christine Lagarde is about as competent an economist as your average brick; and even articles have passed by from the mainstream on how "inflation is good for you". If only you could bottle and sell desperation.
I can't help but shake my head at this madness, especially considering all this debate is happening among people who don't even understand what inflation is. I've written about it in detail in my books so i won't go into depth of what it is in the abstract here; but i've decided i'll have to describe in more detail what it does and what the effects of it will be in our current reality, rather then what it always does. Especially how it interacts with our current fiat system and interest rates.
To recap what's in my books; there's 3 forms of inflation: Currency inflation, Price inflation and Value inflation.
The first one is purely monetary: Print more money, prices go up. This is simple supply and demand; if you have 10 goods and 10 money and then add 10 money, you have 10 goods and 20 money. Divide the goods by the money, and you get 2 money per 1 good, where it used to be 1 per 1 before. This is simple enough to understand. Why it still confuses people i'll explain in a moment.
The second one is based on supply and demand of goods: Even if the monetary base doesn't expand, should demand for a good rise while the supply of those goods stays the same, the price of the good must go up, and more money is required by people through income in order to buy the new goods. People chasing this higher income then causes inflation. Hence price inflation. Why it still confuses people i'll explain in a moment.
The last one is a bit harder to understand, as value is never stated in the price. The price is just a result of all money demanding the object - not all humans. If all humans start demanding things, regardless of function, the value of that object increases. Should that demand wane, the price falls. This happens regardless of the reason for it happening, or put differently, it'll be explained in hindsight regardless of when the line went up. Think Beanie Babies, Tulips, NFTs for extreme examples. The asset is valued for ever stranger reasons until it's valued for the price alone, until that ends and the valuation collapses. Why it still confuses people i'll explain in a moment.
Alright; well, now to clear the confusion.
People get currency inflation wrong because they either are unaware or refuse to acknowledge Location of Capital, which i've often written about before. This is important because it interacts heavily with Liquidity, which in turn is the primary function of money. Location of capital simply means that you control your money and where it flows, while i control my money and where it flows. Liquidity in turn is the availability of money.
Basically put, if you have $10 and i have $10, but you can spend $5 while i can only spend $2, the money stock is $20, but liquidity is $7. Prices then adjust as if there was only $7, rather then $20 in the economy. The money that cannot be spent, cannot circulate between locations of capital, and as such does not have an effect on the prices the liquidity cycles between.
As for money being unavailable to spend, you have to view that from the perspective of every individual location of capital. For example, money that people are forced to add to their pension by law, which in turn can only be invested into bonds or money market funds. This means this money cannot circulate in the "general economy", meaning commodities. It can only switch between cash and bonds. Yes, it affects the price of bonds - but it cannot affect the price of copper if no pension fund is allowed to invest in copper.
This is the reason why there hasn't been a huge amount of inflation over the past 10 years before Covid hit, even though trillions were printed. Via various mechanisms, some by decree (excess bank reserves kept at the Fed) and some by incentive (if the stock market goes up, people won't sell), the money was simply kept out of general circulation. This is also the reason why this time it's different, as the rich are taking it out of synthetic assets like stocks and bonds, while the government is printing money into the general economy via stimulus checks and social programs; and the general populace piled into the stock market and crypto as well, vastly increasing the locations of capital within synthetic markets, and causing the "leaks" of profit taking and dividends to flow faster into the real economy.
It's not hard to understand once you answer the question of "If a trillion is printed, but never moves from the bank account it's printed into, does it cause inflation?" with "No". Which is absolutely true... if the money never moves. Which is why i separate currency inflation into "the print" and "the hit" in my books. The moment a location of capital with alot of capital allows it to move (AKA billionaire decides to all-in on gold), inflation hits immediately - but it could only hit because that money was created to begin with, meaning it was printed before.
Price inflation then. That confuses people because demand is so poorly understood. Demand effectively means desire, but in economics, it's described as "the point of sale" only, because that's measurable. You can't calculate "why" and "when a person decides they like something", so it's useless to mathematical models. Estimations and Averages are the best people can do. Which is why price inflation confuses the fuck out of academics.
Desire doesn't really have to have any sort of logical or reasonable explanation; just ask anybody who's ever been in love. If people become infatuated with an asset, they will chase it against all reason (Bitcoin, GME, AMC). And since people control money, they will easily throw all their money against it. Naturally, if more money requests the same asset, the price will go up.
So far so good, but what's supposed to happen, is "demand destruction". Meaning, the higher the price gets, the fewer people that can afford it, so supply and demand equalizes. Less assets at higher prices will be sold until extra supply is brought online and reduces the price again. And why this hasn't happened to supply chains has baffled mainstream "economists".
But it's really simple: Demand destruction only happens when people run out of money on average. One person running out being replaced by another fool with money, doesn't do anything. Similarly, if the people can afford the higher price, demand destruction cannot happen. They will simply spend the higher price, and the process continues until enough people run out of money.
So where is all this mystery money coming from that keeps pushing up price inflation? See currency inflation. Demand destruction will happen unless there's a reservoir of money out there that people can tap into to afford the higher prices. Savings, credit, stimmy checks, profits, diverting from other assets, it all works. All that matters is whether more or less money is purchasing those limited amount of assets, so all that matters is whether that money is available among all people chasing those assets.
And when i say "people" i don't mean "the peasants" or Joe Sshmoe, i mean everyone. Including the hedge funds, corporations and billionaires. If Warren Buffett allocates one third of his cash into the Uranium market, the entire sector more than doubles in market cap.
Where we come to the confusion over no.3; value inflation. What is value? Well it took an entire book of its own to explain that, so expect the cliffnotes version here. Value comes out of the functionality of the object or service you purchase. Scissors have the value of Scissors; they cut. If you have nothing to cut, scissors have no value. Same with gold: Gold has the value of Gold. Even if you can't trade it, you can still make shiny jewelry out of it. The asset's Utility value is closest to its intrinsic value, though there's more to it than that.
Since value isn't contained within any number, but within concepts, it's really easy to convince people the value of an object is different from its actual value. Bitcoin for instance has an intrinsic value of 5 transactions per second, because it's the network that gives Bitcoin it's value (the individual coins do nothing on their own without the network); and that network is capable of doing 5 transactions per second maximum. It was specifically designed this way, so it won't ever be able to do more. As software, Bitcoin's functionality can be changed (Lightning network, Taproot), but that in turn also changes the value of Bitcoin: It becomes more or less valuable, as it in essence becomes Lightning Bitcoin or Taproot Bitcoin, just like gold jewelry is different from a gold bar and thus valued differently, while both being gold.
So in all respects, as a transactional network that requires the power of a small country to do 5 transactions per second at most, it's completely worthless. Yet people have gone on believing it's the savior of mankind despite these glaring issues - while at the same time promoting stuff like Taproot and Lightning as the solutions to scaling. Well what is it guys, does it or doesn't it have value?
The answer usually being it will have, which considering it happens in the future which nobody can discern upfront, is a perfect place to hide bullshit that alters the perception of value within any asset. That's what value inflation is, the changing in perception of the value of assets, as the value of assets can't change - they are what they are. It's us that dynamically value stuff more or less. Not the cats.
And once the perception of enough people changes at the same time (and no i don't know what this critical level is at any given time), it can cause inflation. Simply through the above mentioned process of location of capital: Elon Musk currently values Bitcoin alot, since he bought alot of Bitcoin with Tesla. This caused a massive appreciation in value of Bitcoin, as more people gained a favorable perception of Bitcoin. Should he sell it, that paradigm flips, and Bitcoins perceived value declines.
While that is still a singular asset, if an entire sector of which we know the value of increases in price anyway, problems start. For example, if food prices rise and continue to rise, people start expecting more expensive food. They will frontrun this by buying extra food up-front to take advantage of lower prices now VS higher prices in the future. Since this would be true for all humans within an economy - and humans aren't nearly as unique as each and every one of them thinks they are - money starts draining out of stationary locations of capital and starts circulating in the general economy.
Not just people's savings, but investment money into financial derivatives of said assets too, which worsens things. You can't buy a thousand breads as an investment, but you can buy Wheat Futures, which does affect the price for delivery. As more money becomes available while higher prices must be paid for mandatory expenses such as food - prices continue to go up and continue to be afforded, disabling demand destruction! Extreme cases of this we consider "panics", where everybody spends everything they have on the same thing at the same time. The Toilet Paper Panic of 2020 is going to forever count as a historic example of this. Including its effects of running out of an abundant asset through the breakdown of logistics.
This doesn't just happen in panics though. It can happen over time too, where people more and more start expecting higher costs later, so they're more inclined to spend as much as they can now. As long as those costs are limited to one or a few sectors of the economy, it doesn't cause high inflation. But the more sectors that are valued higher, the more an overall drain on the budget those sectors will be, and thus the higher they push the individual's demand for more money. Individuals will demand this money through wages, which starts a wage/price hiking cycle for companies. Here, the value inflation is in the value spending money now brings VS spending it later, as spending it now brings more benefits than holding it to term, simply through the rapid devaluation of money through price rises, perceived or real.
Alright - now that everybody's gotten a crash course on inflation, let me explain how the various forms of inflation are interacting right now and how they'll prevent inflation from coming down. I'm basically just going to run through every possible imaginable option available to central banks and policy makers right now, and show how every single one of them leads to either hyperinflation, or a crash and then hyperinflation. Please keep reading if you want a preview of highly probable headlines over the next 3 years.
Lets start with Interest rates, since that's the talk of the day. The Federal Reserve is preparing to raise interest rates to "tame inflation". But why does that work in the first place? Why does increasing interest rates reduce the rate of inflation, historically speaking?
Well, that's because of what money is and how it's created. In our modern fractional reserve system, Money = Debt. That means that money isn't printed into existence, it's lent into existence. This does indeed make the dollar, euro et al Money, and not Fiat currency, meaning money without any link to intrinsic value. This is a mistake often made, but it's easily proven:
Does the process of lending, have value? That is to say, does it serve a purpose within society that adds a benefit to society?
Yes it does; it allows us to time-compress labor value and rather than saving and paying for value up front, we're capable of paying for value now and "refilling" that debt with the value produced with whatever we're paying for. In terms of industry, it's a very valuable process, even if it sometimes goes wrong, simply because it cuts out the overhead of surviving upfront in order to generate and save enough currency to start a business, by making use of prior value created by others to compound it. In terms of consumption it's detrimental as consumption can't compound value and rather destroys it, but that's another article.
Point is, lending has value. And if lending has value, debt too has value. As it's impossible to have debt without a loan (debt can't materialize out of nothing), or a loan without incurring debt (that'd be a gift). If debt has value, then the currency based on debt has value too. Where under a gold standard the currency would have the value of the gold backing it, under a debt standard it has the value of the debt backing it. This might seem a bit too indepth now, but it'll become very important later.
There's 2 "entities" within a fractional reserve economy as we have that can lend money into existence:
1. Banks included within the Central bank's network.
2. The Central bank.
The reason why raising interest rates quells inflation under normal circumstances, is because of the banks. Citizens deposit cash into a bank account, which the bank is then allowed to lever up a certain number of times. If that number is 10, then every $100 deposited can be used as "collateral" for upto $1000 in loans. When lent out, this money is effectively printed, and when it's returned it's destroyed again, minus the principal (the original $100) and the interest paid over the loan.
That's the banks bread and butter, or atleast it used to be until rates to were set to 0%. When interest rates are higher then inflation, the money that banks "earn" is the difference between the interest rates on these loans and inflation across the entire monetary stock. If you're wondering why credit card loans are at 17% interest while the Fed Funds rate is at 0%; that'd be why. The CPI's alot higher than 7% in reality or the banks would be making ungodly amounts of profits (as compared to their regular demi-godlike profits).
Naturally this interest comes from somewhere; that being the person who took on the loan. So it logically follows, that if any person has to pay more interest on their loan, and thus their monthly payments go up, fewer people can afford to take out a loan. After all, the higher the interest you pay, the more value you have to create within a shorter timeframe in order to exchange for cash, and not everybody has that ability.
Thus, if less people take out loans, less new money is created, and inflation drops. Again showing how full of shit Jerome Powell is because you can't at the same time claim to raise interest rates against inflation AND pin it on supply chains. It's either monetary or it isn't (but if it's monetary it's his fault).
New money stops being added in terms of bank income through interest and in terms of how much new money is added to the economy that didn't exist before; leveraged dollars vs principal dollars. Raising rates slows the banks ability to print money.
It also contracts credit as fewer people can afford to borrow.
And here we come to the first reason why inflation will continue, it's something i've detailed before in my other article "The Problem is Too Big":
The US tax base consists of Zombies. Yes, the zombie apocalypse actually happened - but it was the D-virus that spread, not the T-virus.
Some companies are considered "zombie companies" because their debt load has grown too large compared to the value they produce, and as such, can only stay alive by incurring ever more debt. In essence they look for credit equally mindlessly as the way zombies look for brains, as any possible funds that could be used for innovation or expansion are going to debt service instead. Should their ability to find funding stop, they die in bankruptcy. It's never a question of if, only when.
And the US tax base is in no better shape. The details are in the other article, but for this one, it suffices to say the Total United States debt currently stands at $86,3 Trillion. Alot of attention goes out to the National debt, which is soon to hit $30 trillion - But who is going to pay that debt back?
The US Tax payer that is. And the national debt isn't the only debt they have.
Personal debt stands at $21,2 trillion. This is nearly US GDP by itself, and i assure you, that "nearly" is going to disappear like smoke in the next stock market crash. US Corporations, the only other tax payers besides individual persons, have another $11,4 trillion in debt, pushing it to a $32,6 trillion total and past the national debt.
The people responsible for paying down the national debt actually have even more debt themselves!
So it doesn't take a genius to figure out (but apparently more than the fucking morons working at central banks) that raising interest rates, and with it contracting credit, is going to end very badly for the US consumer, who is living off revolving credit. Before the pandemic hit, we were already in the late stages of the business cycle, where credit is overextended - and then we forced everybody to stay home and eat into savings and credit while making credit easier than it has ever been.
Can they raise rates? Sure they can, because at these low rates with bond rates already increasing, 0,25% is going to do very little. However, a 1% rise on any maturity will already hurt alot, let alone the ~5% the US 10 year needs to go up to hit historical averages. At which point it'd still be overpriced, as the finances of the US are in much more dire straits than ever before; and that commands a premium.
The problem isn't that they can't raise interest rates up to 1% - it's that they need to raise interest rates to 7% in order to start impacting inflation, as then it equalizes with the CPI and people start earning currency on savings as fast as inflation is taking it away. Inflation is a devaluing of the currency, and if you want to change inflation expectations, you need prices to stop going up in real terms. Going up "less fast" doesn't cut it, as things will still get more expensive later which generates expectations at the register. All of which is assuming, yknow, that the CPI wasn't massaged into oblivion and is probably closer to double in real terms.
The indebtedness of the US AND its tax base prevents that rise in interest rates to an effective level.
If the US tax base has to pay more on ALL their debts (mortgage, student, car, personal, payday, credit card), the interest expense increase is going to sap all additional spending, including mandatory spending such as food. Yes, they won't be able to lend any more, but killing the patient isn't a cure.
Further more, that's just the US tax base responsible for the debt - the national debt itself will also become more expensive at higher interest rates. Treasuries carry the interest rate of whenever they were issued: If the interest rate is 1%, the bond will still have an interest rate of 1% in 10 years time even when inflation runs at 5000%.
The problem comes when a new bond has to be issued - bonds are always issued at current interest rates. So if you have a 1 year treasury at 1%, and 1 year later the yield is 10% - while you haven't been able to pay back the loan - you need to "roll it over" at current interest rates.
And that's how it starts hurting the US fiscal budget. Because the US has a tremendously large pile of very short term debt now after 2 large crisis, any rise in interest rates starts hurting the interest paid on the US national debt very quickly. I came across this recent chart from Yardeni research that perfectly encapsulates the problem:
More shocking charts can be found here: https://www.yardeni.com/pub/usfeddebt.pdf
While it'll take some time to move up to the 5% number, as it takes some time for the US to roll over its debt - the US has alot of short term debt. Its average maturity is only 72 months - 6 years - on a pile of $30 trillion (the non-marketable stuff still has to be paid back).
In short - not only is raising interest rates going to squeeze the US tax base and make it much harder to pay back the national debt by making raising taxes on a percentage basis impossible - meaning more debt will be incurred - it's also going to rapidly raise the interest paid over the pile of national debt already incurred, which is going to make balancing the budget away from a budget deficit (and thus more debt) impossible as well.
So yes technically the Federal reserve can physically raise interest rates, even without actually causing an economic crash probably - at first. But within a year they'd be back to cutting interest rates, as no one in the US can bear higher interest rates for long. Raising interest rates to stop inflation isn't possible as interest rates CANNOT stay high for long. The only exception to this is if the Federal Reserve deliberately raises interest rates too slow, continually running behind the curve, as that effectively does nothing, and (hyper)inflation just continues at a slightly slower pace.
However - this is just one of the myriad of reasons why inflation is here to stay; interest rates cannot be raised above a level where they affect inflation. Next up, let me tell you why even interest rates DOUBLE the rate of inflation won't do anything.
This has to do with the 2 mentioned far above; the Central bank which is also capable of lending new money into existence, since they still exist and they'll react to the above process playing out. Meaning they'll raise rates until the market forces them to stop, upon which they'll cut rates again and restart QE. It's literally all the tools they have, regardless of how much they jawbone the markets with the tools they have. Only this time, the market is going to ignore the Fed's fund rate and increase yields anyway. Infact, with rates still at 0% and atleast $60 billion in QE a month, the US 6 month is already trading at the same interest rate as when the Fed's fund rate was 0.40%.
See, while money has been coupled with bonds, this doesn't mean that government bonds aren't their own thing serving their own function, just like a gold bar is it's own thing that can be turned into jewelry regardless of what currency is pegged to it or not.
What everybody seems to have completely forgotten in these highly manipulated markets, is that Bonds serve the function of determining a sovereign's creditworthiness. When a nation (or a person for that matter) wants to lend money, the market will look at how creditworthy they think that nation is, and the average of all interest rates charged to the government is the eventual market price of the bonds. If the market says you can lend at 7%, then the market thinks there's enough risk to charge you atleast 7% extra money on the loan. The more likely it is that the money comes back, the lower the interest rate.
In an unmanipulated market. Meaning, where all participants adhere to the same economic rules and limitations. Namely, not having unlimited amount of funds available to you at no cost whatsoever.
Central banks don't have this limitation. They can buy bonds forever. So it's manipulation, as they have no need to set limits or constraints that everybody else is limited by, the constraints the market functions on. Hence, many government bond markets simply aren't functioning properly. Which has distorted nations' ability to lend, and even economic theory because it went on for so long people have forgotten the actual function of the bond market (what the actual function guys, c'mon).
Individually. Shame that the market runs on group behavior and dynamics. Ysee, no matter what bullshit everybody spouts; when it's just them and their trading screen, which tells them they're down 10, 20, 50%.... eventually they'll sell regardless of their beliefs. Maybe some zealots won't, but there's very few of those to go around, certainly not enough to make a market. Reality always demands payment.
Basically, the fact that bond rates are moving up against the effective feds funds rate means the US bond market is now in open rebellion against the Federal Reserve, and nobody seems to have noticed or care yet. Otherwise, why have bonds start front-running the end of taper and imminent rate hikes, rather than waiting for the Fed to hike rates in March like everybody expects them to now? The picture above is clear, the US 6 month has followed the Feds Fund rate very closely for a decade. The fact that it now has stopped doing so, means something is materially different. It's already trading like it's July 2022, like the Fed already hiked twice. It's JANUARY!
As i've been trying to tell everybody, manipulation doesn't mean one controls the entire market. Sure, one can affect the price of an asset, but it's not like there's some form of external mind control happening here. Con-men can make use of natural human tendencies, but they can't make you do something you don't want to do yourself. Just because the Fed is the buyer of last resort, doesn't mean everybody else will forever-hold their bonds!
And if the market sells their bonds faster than the Fed is buying them, because the selling happens faster than the rate the Fed has set the bond buying at (and no additional market demand steps in), yields move up regardless of the feds fund rate. Which is exactly what the chart shows.
What's happening can be described in just 2 words, the 2 words the Federal reserve fears more than anything else in the world right now: Price Discovery.
Everybody's been so focused on yields, they forgot about bond prices. If everybody sells bonds en-masse, which drops the price, it spikes yields. And the 6 month yield has been moving up ever since Taper was started in November - even when the balance sheet of the Fed hasn't actually stopped or slowed down its expansion (so far it's been a bluff) - and the 3 month yield has started blowing out since the Fed's participants mentioned quantitative tightening in the minutes on the 3rd of January. The 1 year yield started its journey up in October and by one count as early as the middle of June 2021.
Also they mentioned QT, they didn't implement it. QT being the opposite of QE, where the balance sheet is reduced and more bond supply is added to the market. This reduces the amount of money in the market yes, as the money the Fed receives for their bonds is destroyed; they have no need of a cash balance sheet after all.
But it adds bonds to the open market. Supply and demand counts for everything, including bonds, meaning more bonds at the same demand = lower prices. Since prices and yields are linked, lower prices = higher yields. Ergo, IF the Fed were to actually employ QT, bond yields blow the fuck out like you didn't expect was ever possible. Those comments are ENTIRELY predicated on the belief there's still an actual market demand out there for THIS many treasuries, let alone more.
WHILE the United States government HAS to run a budget deficit because the interest paid on the national debt increasing with higher interest rates, meaning the government will loan more, not less, and even more bond supply is added to the market, leading to even higher rates.
Yes, this leads to the point where the US government simply does not have the ability to lend anymore. That is the point! This isn't because anybody has anything against America per se, though plenty of people do anyway. This is the actual fucking function of the bond market! To determine if ANY government is supposed to be able to lend more. And when the US is this indebted, they shouldn't be able to lend any more!
Which is exactly what the bond market is telling us now by rebelling against the Feds funds rate (and i cannot believe everybody is snoozing on this. Bond experts my ass. I should be seeing alarmbells all over Twitter).
But it gets worse, ofcourse it does. This is only the second reason inflation stays; the bond market raising interest rates by itself due to oversupply of debt and the emergency QE that'll follow to soak up that supply pushing new money into the system.
The third reason is the devaluing of the currency. And no, i don't mean printing more money, that's the numerical symptom. In a pure fiat system, yes, the more money you print the less value it has, because it's a pure numbers game: When the Government pulls in more money in taxes than it prints, there's deflation, when they print more than they take in, there's inflation. As simple as that - though we've only seen the inflationary situation within history as nobody ever switched off a gold standard to pure fiat during a budget surplus. It's always done because more money is required than can be accumulated in goods, so the difference is printed.
It goes to what i explained above, the nature of money being debt. As money IS debt, it shares the same fiscal properties as debt. Just like under a gold standard - if backed 1 to 1 - the currency takes on the fiscal properties of the gold. If there's a liquidity crisis in gold, meaning too little gold is available - automatically, there'll be a liquidity crisis in the currency, as in order to create more currency, you have to find more gold, which no one can because there's a gold liquidity crisis.
With Debt this won't happen that quickly, as Debt is Ethereal; that is to say, it doesn't exist in reality, only as an informational agreement between two conscience entities. We can continually make new agreements by simply agreeing to them, as opposed to gold where agreeing to pull it out of the ground doesn't actually pull it out of the ground. Two parties agree to debt, debt is created, that simple. The hard part is getting two parties to agree.
The same still applies for the transfer of value. A currency backed by debt will retain the value of that debt, as long as the amount of currency represents the amount of debt. This last bit is automatically achieved by denominating all US government debt in dollars.
So if the debt loses its value, the money loses its value!
Currency backed by debt can transmute into pure fiat currency, if the debt backing that currency has no value in and of itself. Since that property transfers, the currency will not have any value in and of itself. Since you're back to Fiat then, it goes back to the numbers game of "taking in more or less than you're spending" - and in the case of the US government, it's easy to predict whether spending is heading up or down from Zero overspending. As long as they overspend, they devalue the currency, just at a faster or slower rate. Should they run a surplus, there'd actually be deflation - but again the problem is getting there.
To determine whether or not this is true, we have to look at how debt has its value established; though it's important to preface again that price and value are 2 very different and separate things. Price is a reflection of value, but that's all it is - a reflection. Not the actual value. Just like the Mirror of Erised from Harry potter, we sometimes get lost in what we want to see rather than what's actually there. But that doesn't mean there's nothing there.
The value of debt is in the money you can earn with it, namely the interest on the loan, versus the risk the money isn't going to come back. This latter half of the equation seems to have been forgotten since central banks as a buyer of last resort made sure that every bond holder that wanted to sell, could. This same component is why money as debt gets confused as fiat often, since fiat relies on pure faith, while debt only has a faith component; namely the risk that nobody knows the future and you're just going to need to have faith whoever you're lending to can deal with adversity, to mitigate events that could lead to default on the loan.
Upon reaching a critical level in the supply of bonds - though i couldn't possibly tell you upfront where that level is - the ability to pay the bonds back starts to matter more than the actual money you're getting back. To put it differently, "I'm not sure i'll get my money back in 5 years, so why would i buy a 10 year bond?".
One would expect once that question returns as true, the 10 year bond market collapses. However this is not what happens in reality, as there's a secondary market for government bonds. Even if one can be assured of total destruction of a country in 5 years, they could still pay back loans for 5 years. Even 10 year bonds would keep their value, as long as they can be sold to somebody else before the end arrives. In effect, "the market" can "pay you back" just as much as the government can, because cash is cash.
As long as there is a market to sell into, the bonds won't ever fall too much, because whenever they get "oversold" in the short term, market participants will buy them regardless because of an expectation of short term price gains. Only when an asset is so toxic that nobody wants to take the risk of owning it at all, does the market go no-bid and does it collapse entirely. But it is true that in a bond market collapse, the longer end goes bidless first and the above described utility function shifts to the shortest end of the curve and concentrates into a single superliquid market - as exemplified by the extremely inverted Venezuelan yield curve.
It's this property of the markets that the central banks of the world have made copious use of, especially since 2008. The United States national debt has been unsustainable for years, but nobody cared as US bonds were rising in price (or going sideways) and as such still served a function as a transitory store of value; and Western economies' historic reputation for being financially prudent allowed everybody to be lazy for a long time.
That party has finally ended after a 40 year bond bull market.
While the trigger was the massive amount of money lent by governments all around the world at the same time during the pandemic, really what's happening now is just a process of more than a decade of eroding the faith in central authority, both central banks and governments. Which is why the bond market has already starting to ignore the feds funds rate.
Not everyone believes they will be able to sell their holdings into the market without any significant loss anymore. As always, everything is a process. If you're holding a crapton of bonds, and you want to sell out of them, you don't sell the lot right away and cause a panic. You ease out of them over time, especially selling into strength whenever you can, and making use of "oversold" indicators and such to play the market. Since the 6 month treasury has been steadily selling off since November, ever since the taper was announced - and the 3 month joining it since QT was discussed - i'm pretty sure we can establish a pattern with a cause here. A moment of very public information spreading across the market instantly and causing all participants to take the same action individually and independently, which i've talked about before in my books. This was only solidified by the horrible recent press conference.
These actions are predicated on the loss of faith in the central authority of the US. Bond market participants simply don't believe the rates can be raised for the reasons mentioned above, so the market is trying to figure out exactly where the pain for the central authority gets too bad and the printer is switched back on in order to buy all their bonds. As long as the central authority, in this case the Fed, doesn't switch its position from raising rates, the market will do it for the Fed until they flip. If they never do - rates never stop going up and we get the ultimate crash sooner as the entire curve goes no-bid.
The problem here is the signal of rising interest rates isn't a sign of market stability or growth - it's the start sign of the end we've all known was always going to come. Once they force the Fed's hand, bonds will initially spike in price as the Federal Reserve adds cash liquidity to the market, but afterwards they will crash twice as hard and fast, as nobody is actually selling to eachother anymore, only to the Fed - and this level of selling will continually be tested as everybody wants to be the one to sell to the Fed while the bonds are still worth something.
The buyer of last resort becomes the buyer of only resort. So prices will continually slide while yields move higher, seen or unseen (in the case of yield curve control; that just breaks at some point under the pressure and rates pop or the market goes bidless entirely when all bonds have been sold to the central bank).
Again, this is already happening, as the Fed hasn't raised rates yet (and isn't planning to for another 2 month atleast!), and they've been bluffing on taper so far. A quick look at their balance sheet says their printing rate hasn't changed much since August of 2021.
So my only explanation for yields marching higher is more supply than demand is hitting the market. And the Fed here is included in the "Demand" side of the equation. Since the market is outselling demand, yet the Fed is still printing - we can only conclude that $120 billion in monthly QE isn't enough anymore.
QE needs to go up, not down, in order to stop rates from rising, even from its previous level.
You could say "Well, we wanted rates to go up anyway to temper inflation, and forcing the government to spend less is a bonus, so what's the big deal?"
The big deal's that would be confusing cause and effect of separate problems happening at the same time. Effectively, this problem i'm describing here has nothing to do with inflation! Inflation here is a symptom, not a cause. If the yields are rising because of a demand issue with bonds, there is no stopping this. The market no longer wants US debt!
If you pull a pandemic and just ignore that problem until it becomes untenable, all you're doing is speeding up the collapse by destroying even more faith in your competency. Everyone knows the Fed will be forced to buy the Debt anyway because the only other option, the federal government cutting spending down to a budget surplus, isn't an option. Mathematically.
The only choice becomes sacrificing the dollar to save the bond market. You can always reset the currency after clearing the debt. I'm sure you've heard people say the only option is to "inflate away the debt", which is true - once the debt has become worthless and is reset to nothing, new debt has value again, as the unencumbered debtor won't have much problems paying back a little bit of debt. Ofcourse it screws over literally every bond holder - but there's always gonna be losers, even if that means tens of millions of people.
I guess purposefully throwing in the towel and defaulting on the debt is also an option, but one never before taken in history. The politicians always run things into the ground because a smooth decline gets them killed slower than an instant deflationary crash. No populace is going to go for that. You have to effectively manipulate everybody into accepting the end willingly, which means gradually.
Here we reach another reason why inflation isn't going away, and even why hyperinflation is assured. Since money is debt, if the crisis is too much debt - you cannot solve that with more debt!
Liquidity crisis - meaning a shortage of money - will become indistinguishable from solvency crisis - meaning an inability to pay back debt - at the end of a fractional reserve system. The moment a solvency crisis erupts, it starts soaking up liquidity by freezing credit. This automatically leads to a liquidity crisis, as there is more debt than liquidity, since the whole problem is being unable to pay the debt back.
This can only be solved by adding liquidity to the system. This is true for any bankruptcy, where somebody steps in to provide bridge loans during the bankruptcy. But since adding liquidity in fiat systems which have too much debt basically means lending more money into existence, more liquidity automatically means more debt.
You cannot solve too much debt with more debt!
There is no solution to this. Every injection of liquidity causes the solvency crisis to go away for a while, just like taking out a large loan with a small monthly payment does. As long as you still have money from the loan for your obligations plus the interest payment, the solvency crisis continues to simmer below the surface.
But the additional liquidity, as long as people don't go bankrupt, has nowhere to go! It's supposed to be compensated for by writedowns, but paradoxically, if you still have a crapton of liquidity, there's no need to write anything down!
As zombie companies and indeed, an entire zombie economy still bleed money, that money eventually finds its way to the general economy; while the people who are dependent on ever increasing credit get into trouble again and need another credit injection. And it seems that all the money printed since the Repo Crisis in 2019 including the monthly QE was only enough to get us until March 2022 at the latest.
At that point, the Fed either prints more than $120 billion in QE a month, or we get another solvency crisis (meaning a deflationary crash); upon which the Fed will print substantially more. Meaning another two months of $1 trillion each as in March/April of 2020, with the exception that this time, the QE afterwards is going to be atleast $300 billion a month instead of the ~$200 billion they could get away with now.
They'll let it crash as raising QE now would be a total admission of guilt and helplessness - which they will never do - so the market forcing their hand is what'll happen.
That money will last us another good while, but inflation will blow out for anybody using dollars. This includes the US but also the 3rd world nations that had previously seen their currency implode and have since "dollarized". Since they are included within the dollar ecosystem, effectively their economy implodes again, as their store of value gets wiped out the same as for the people within the US. Changing the peg to another major currency like the Euro won't help either since they're all in the same boat at the moment.
Since bonds are denominated in dollars as well, and the dollar value of the bond actually is principal plus interest MINUS inflation - more bonds will be sold, bringing back the solvency crisis eventually where the government can no longer pay its current debts simply because it doesn't have the ability to lend more in the open market to roll over its current debt - leading to the only option left, an increase in QE to soak up the new supply and stop interest rates from going up, which causes more inflation, etc.
Which leads to another reason why hyperinflation isn't going to go away: The rich and successful who can all see this process play out just as well as i can (because if they can't, afterwards, they won't be rich or successful anymore). They have no need or obligation to buy US bonds or any sort of dollar derivatives.
Warren Buffett with Berkshire Hathaway has $150 billion in cash under his control. Currently, that money is mostly located in short term treasuries (durations of 6 months or shorter). So far i've been focusing on central banks and banks printing money, but this is not actually where hyperinflation comes from. Sure, you need a large amount of money increase to get hyperinflation - but as stated value inflation can happen in anything, as long as people want it en-masse. The reverse is also true; if the value from an asset deflates massively because everybody rejects it, anything can become worthless. Including any currency.
Velocity is still a thing, even though it's always poorly calculated. It basically means how quickly a person will spend their money, as money which is saved isn't circulating and thus does not affect prices. The more people save, the lower velocity is because money saved is money not spent.
Which is also exactly why velocity has cratered ever since QE was introduced, since that's liquidity that is focused on the stock market, which is mostly owned by the rich, and the rich have no need to spend. How often does one buy a yacht or private jet really, especially when you can let it ride and buy two jets or yachts later! The Nasdaq went up 10 fold between 2009 and 2021; that's enough of a distraction for anyone.
Since the money wasn't available to the general populace with a need to spend, while the rich had no need or motive to move it out of financial assets, there hasn't been any notable inflation between 2010 and 2020 - the inflation that did happen consisting of the "leaks" out of synthetic markets such as dividends or coupons (which counts as new income). The CPI measurements of the last decade basically equated to measuring the water pressure in pipes by looking at a leaky faucet and concluding there's no pressure in the pipes as the water barely flows out.
When people realize this foolishness en-masse and the credibility of the Federal Reserve finally dies, all the people who already have money, will move that money into value-preserving assets in order to try and hold on to as much as they can. Not because they will want to, though there's that. But because they have to.
Which brings me back to Warren Buffett, and my story above of how bonds continue to be bought as long as they serve the function of liquidity (AKA being able to sell them tomorrow rather then hold them to maturity). Ysee, there's one thing i left out of the bond's value calculation and that's its current price.
After all, if you're treating bonds like money, the coupon doesn't matter. Which has been the prevailing opinion in bond land for a decade now anyway thanks to ultra low rates. All that matters is what the price is when you buy, what the price is when you sell, and the difference is how much money you made or lost. The same as with any penny stock really.
Yet they're still dollar denominated assets. So the real value is:
Current price - purchasing price - (inflation - yield).
It doesn't matter what inflation is or how much the bond yields if you buy a bond for $1000 with the intent to sell it for $1000 and the price drops to $900. At that point it's just another asset you wanna buy low and sell high, so if it starts dropping, people start unloading.
For Warren Buffett, up to this point, inflation wasn't a problem. Inflation might devalue currency with a percentage, as long as you can increase your own income beyond inflation, there still isn't a problem. And CPI inflation between December 2020-2021 might've been 7% - Warren Buffett's cash pile increased by 8,9% since March 2020. So effectively (more or less), he gained 1,9% more money over that period.
BUT! If he has to add to that 7% inflation, a 10% drop in the price of short term bonds because the Fed raised rates or the market did it for them.... Well, at some very quick to reach point, it becomes his fiduciary responsibility to his shareholders to spend that money on anything that doesn't lose 17% in value per year. Even growing his cash pile by 10% would be offset by an additional loss of 7% on his storing mechanism.
And that's Buffett. There's hundreds if not thousands of lesser-rich-but-still-very-rich people stuck in the same boat, if not a quicker sinking one. They won't be given a choice but to spend their money, which increases inflation, which feeds onto itself in a vicious cycle of ever more money becoming available as they're not liable to sell those assets back for currency either. So far, the Fed's effectively been controlling everybody by controlling rates and keeping them steady, but that's ended now. The Fed has no direct means of control over Warren Buffett's money. It can only incentivise Warren to stay in cash for so long as the value of cash stays stable enough to make it worth his while - and the same is true for every other player in the markets.
And this still isn't everything. Supply chains still matter and are another reason inflation will stay prominent. I've already gone more indepth into what happens when supply chains get overstretched in a previous article:
While inflation is most definitely arising out of monetary effects, that doesn't mean the lack of goods doesn't impact the need for liquidity and inflation with it, by drawing more currency into circulation out of the stationary money stock. Naturally, the increase or decrease in one good doesn't do much for the general demand for money.
But when it's all supply chains at the same time, say due to a global decree to shut down industry as much as possible (to the point where people living in heavily polluted areas could see further than they ever have within their lifetime), then that does affect the prices of all items and input costs of all services, leading to general price pressure. Which does increase the general need for currency, and thus causes inflation. Just because governments and central bankers use it as an excuse to hide their incompetency, doesn't mean they don't have a point.
Though again - this inflation wouldn't be possible if there wasn't already a large currency stock to drawn upon. If this money stock isn't available, demand destruction happens instead, and people are priced out of the market. This in turn immediately explains why the supply chains haven't recovered yet, when they were widely expected to. By the time the pandemic hit, the available money stock was already extremely high - and extremely concentrated in synthetic assets compared to commodities, leading to a historical spread in value perceptions.
And then we limited the supply of virtually all commodities ontop of that. And as i said many times at the time, that doesn't have an effect right away. First the producer's supply buffers are drained, and after that the raw resource producers inventory is drained as the producer orders more. Once both buffers are gone, the entire chain moves to an "Auction" process immediately, where the person who bids the most gets the goods and the price increases are moved directly and rapidly to consumers.
I wonder when that moment arrived for producers. The German PPI shows off the curve the smoothest i feel.
Sure, there's an answer to this to make it go away: Demand destruction. People HAVE to be priced out of the market, so that people stop demanding finished goods. Since so much is bought on credit these days, that means a credit contraction or at the very least stagnation - meaning a lost decade if not more. Even that won't immediately solve the problem since inventory needs to be refilled, so prices will stay high, but atleast the increase would be halted.
The safest way would be banning lending altogether minus revolving debt. Meaning people can get new debt to replace the debt expiring that they already have (because remember, massive amounts of debt mean interest rates cannot rise above inflation so decrees is all you have) so a credit contraction among healthy businesses is avoided while the zombies die. Unfortunately, even a transitory pause in credit would hurt the bottom line of businesses, which would see earnings and guidance plummet.
As the market recently found out with Netflix, the end to ridiculous growth for companies which have taken on a massive debt load on the assumption this growth would last forever so they would be able to pay it back in the future, isn't a good thing. And while i'm no champion of the current overvalued stockmarket, if shareprices are high, more capital can be raised from the market through share offerings. While that negatively affects shareprice, being unable to raise capital in the market when interest rates are going up naturally is going to hit these companies with a double whammy of frozen credit markets and declining share prices.
Many will not survive. That'd collapse the US corporate debt market, which'd collapse the banking system by itself considering it's $11,4 trillion in size, which'd have a cascading effect across all other markets. If the market survives the liquidity crunch, it won't survive the panic printing which'll make all other printing in history combined look like a blip.
That's not even mentioning the bastard child of Wall Street and Supply Chains: Supply Chain Finance. The sector Greensill belonged to, and i doubt that'll be the first and last large collapse we'll see there, including scams. With PPIs blowing out on a global scale, it shouldn't be too long now before people start throwing in the towel. Maybe they're still waiting to see if it's transitory as the ECB still insists on saying, but i'm pretty sure when the fertilizer shortage comes to haunt food by the spring harvests, all hope will be lost.
And it shouldn't require much imagination to figure out once supply chain finance companies go, the companies they service shut operations as well (at the very least temporarily), which isn't going to be good for the supply of goods, which in turn is going to be reflected in the prices. Very quickly this time, as there are no more supply buffers to drain on in an emergency thanks to the rampant printing of money, and infact refilling inventory adds to price pressure now.
In that sense, as i've said often, Covid didn't change anything but speed things up that would've happened anyway. Without lockdowns we would've drained the inventories more gradually, and thus the PPI curves would've been more gradual - but they would've tilted up regardless as the supply of money started exceeding the supply of goods after a financial crisis.
Doesn't mean the PPI can't decline anymore, by the way. We will have some opportunities along the way to mitigate some of the coming damage if we're smart. By keeping production low while gas prices come down, more gas can be diverted to refilling the reserves, causing the PPI to fall less during summer but preventing another, bigger spike by not heading into another winter with sub-average reserves.
Then by keeping consumption low during the winter producer reserves can be refilled as well (Cancel the 2022 holiday shopping season! One does not need presents to celebrate Christmas and it'll be a good chance to reflect on the rampant consumerism of buying on credit that got us here in the first place. Credit card usage always spikes before Christmas). That then causes a dip in shop revenue but that can be compensated for by 1 more support package.
That'll cause some monetary inflation, but by the next year, energy supplies will be average, producers have inventory which gives raw resource producers some breathing room, and people can use the income not spent on plastic shit to pay down some debt so they have some discretionary room to spend the next holiday season. Debt repayments should also cause some deflation to cancel out the last package's inflation.
Yes - basically create our own supply chain disruption from the demand side, to cancel out the supply chain disruption from the supply side; just like 2 waves can cancel eachother out through interference. It'd be the only way to disrupt the cycle, and the time window for that is limited (might already have passed infact), because if the supply disruptions become entrenched and start compounding, there'll never be an end to it unless demand destruction happens (see the LA container port wait times for that). Which means, eventually, it'll happen on its own. Would you like your flesh cut and stitched, or ripped apart by force to heal naturally?
Problem is, that can only work if there's some financial resilience left within the system to absorb the blow of lost revenue/jobs/extra support, etc. And the massive pile of debt spread among all the participants is making the system very fragile to shocks. It'd be guaranteed at this point that "basically shutting consumerism down for a winter" will cause debt implosions somewhere, and it's not entirely possible to say up front where exactly. I think all the other points of this article make pretty clear that'll be afforded by printing much more money, driving prices up further through liquidity overshoots and creating a bunch more debt in the process, repeating the problem.
Maybe successive waves would be needed, each smaller than the next, achieved through selective rationing even when it locally appears there's plenty. One thing that won't work however - and governments are guaranteed to try - is price caps. Capping the price of a limited supply good only prevents demand destruction through price appreciation, and it's not going to stop the increase in liquidity available while governments are still printing money. So if anything - it speeds the process of shortages up, it doesn't slow it down. There's hundreds if not thousands of years of history showing this.
Whatever the case, i doubt the population will go along with the plan to begin with, as they've already suffered enough and don't want to suffer more. It's politically untenable. Which leads me to a final reason for inflation persisting.
Spite. Inflation isn't good for anybody and everybody knows it. "Inflation" to the common person means "paying more for life on a limited budget". So to see the lying government flunkies still called "the media" try and convince people that losing their purchasing power is good for them just to keep them quiet, is infuriating. And the harder they try to make a big deal seem like not a big deal, the more spite the government and media generates. It's no wonder that CNN's viewer numbers have been decimated, and the current convoy trekking across Canada enjoys wide popular support.
While it won't (and didn't) happen overnight, over time, more and more people will simply abandon the currency. They don't like being lied to, they don't like having their purchasing power stolen, and they certainly won't like what's yet to come - such as losing pensions stuck in a depreciating market by another mandate that can't and won't change within any sort of reasonable timeframe.
So, as more and more people start hating the system with a vengeance, they'll exit it without looking back. Crypto might've been a government sanctioned Ponzi scheme to serve as a lightning rod for fiat currency, the sentiment behind many people to jump in crypto was genuine, if somewhat naive. People are looking for a way out of the fiat money system because they absolutely loathe the people in charge of it.
It's only a matter of time before they figure out commodities are that exit. First value-preserving commodities such as Gold and Silver, but as those go up in price and become unfavorable or unobtainable, alternatives will be sought. Platinum, but also other intermediaries like Copper. Once basic resources start becoming unobtainable, anything that isn't nailed down will do, and most of the stuff that is as well. And contrary to normal, every sale isn't a transaction - it's an exit strategy. That person will not touch that money again if they can at all avoid it.
Which shrinks the demand pool for money and reduces locations of capital with it, resulting in more liquidity for less participants for the next round of transactions, repeating until no one is left. Which is a description of the process we know as Hyperinflation.
Personally, i'm already guilty of this. I'll keep my supply of fiat at an absolute minimum until the system has collapsed and reset, and have for atleast 2 years now. Simply because i know it has to happen. I just don't know when. Best not to leave things to chance with something this important and get a head start on everybody else. This is a survival situation. Also, wealth is relative, so the more i preserve the value i possess while everybody else loses theirs, the richer i get. So far, my physical metals and commodity stocks have done well, and the party's barely gotten started.
So to those still expecting any sort of deflation, i would just say: You damn fools. Deflation can only happen if the money supply contracts (Liquidity contracting isn't enough if the money stock stays available in a low/no trust environment), or if the bonds underpinning the currency's value gain in value. Since the US government mathematically can't spend less than they take in and already spent more than they can mathematically can pay back, neither are mathematically possible. Therefore - Deflation is a mathematical impossibility. Any short term spike would be exactly that - volatility within a dying bond market. Spasms during a heart attack.
While i might not know exactly what'll happen when - all i know is, whatever happens, from this point onwards it'll involve much, MUCH more money printing. And so does everybody else. Including reality.
Now it's just a question of when Powell is forced to catch on.
- Kirian "Deso" van Hest.
Find me on Twitter! https://twitter.com/DesoGames
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And buy my Ebooks for alot more content like this!
The Definition of Money: http://books2read.com/u/bzdaVz
The Definitions of Value: http://books2read.com/u/3yaZWv
Ethereal Value and the Cryptofuture: http://books2read.com/u/bMwrNA
this should have been split into at least like...3 or 4 single releases if i suggest so. I somewhat doubt will read it from beginning to end at this length. By the way, buy Monero. Its better than commodities like Silver or Gold, or Bitcoin for that matter.