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MORE ON CENTRAL BANKS
It has only been one week ago when I first pointed out the structural problems that our global economy faces in the first edition of The Perfect Storm for Bitcoin, but what a week it has been. The Bank of England intervened in the financial markets in order to save their pension system, to bring back trust in their currency and to lower the interest rate on UK goverment bonds, as shown in the graph below. In the past couple of weeks, the interest rate on the 10 year UK bond has been going vertical. The central bank warned that crumbling confidence in the economy posed a “material risk to U.K. financial stability. With the current inflation rate of 9.9% (as per official UK goverment data), the central bank would want to increase interest rates in order to cool down the economy and the raging inflation. Last week, however, we noticed the first signs that the debt propped economy is so inflated that the system cannot handle further increases in interest rates (and collapsing bond prices) and the Bank of England had to step up and intervene in the ”free financial market”. Pension funds in particular rely for a large part of their wealth on (goverment) bonds and had major decreases along the line due to the increasing interest rates around the globe (as discussed in last edition).
The Bank of England is not the first central bank to resume their bond buying regime, as the Bank of Japan is buying a larger than expected amount of bonds, while the Governor of the Bank of Japan earlier tried to convince investors that a policy pivot isn’t on the horizon following a wave of hawkish turns by global central bankers. We learned already, in part 1 of these series to watch what central bankers do, instead of what they say.
For example in September 2021, ECB President Christine Lagarde and her colleagues are adamant current price spikes, which drove eurozone inflation to its highest level in 13 years in September, ”are just temporary”. Cristine Lagarde (President of the ECB) said that she sees ” no sign that a recent spike in prices was becoming “broad-based” across the euro zone economy.’‘ According to central bankers around the globe, inflation was temporary and was expected to go down significantly in the following months. This was ofcourse, after stating in 2020/2021 that there would be no inflation due to their monetary policy during the pandemic.
A direct quote, from the Lagarde speech of 30 September 2020:
”That said, market-based measures of longer-term inflation expectations have fallen notably, even when adjusted for various risk premia that can distort the picture. Those measures have also become more responsive to short-term news, which can be interpreted as a sign that their anchoring has softened. Survey-based measures remain more or less within a range consistent with the ECB’s aim (i.e. 1.7-1.9%), but they have also moved to the bottom of that range since 2019.” One further interesting point from her speech: I am fully committed to this vision. Monetary policy can only be credible if we ensure that our goals are truly understood and shared by the people we serve. As an independent central bank, we are and will remain accountable to them.
So far we noticed that central bankers have been wrong about the inevitable inflation coming from their pandemic monetary policy, they have been wrong about the heights of that inflation and they have been wrong about how long such high inflation will remain present in our economies, while consequently stating in their press releases that they fully expect the opposite of what eventually happens before it happens. As by design, the fiat system and their monetary policy can only work succesfully if people perceive their policy (central bankers) to be credible since trust is the only factor keeping the whole system together. The Euro (or dollar) is not backed by anything else except the promise of your goverment that your currency will remain useable and viable in your economy. Their promises that your currency will hold its value, however, is already deteriorating.
MORE ON INTEREST RATES
The cost of debt increases with the increase in interest rates. This is true both for consumers, corporations and goverments. The amount paid in interest will increase when the interest rates will go up. For example, UK interest payments on government debt jumped to the highest level on record last month in a sign of the limited fiscal space available for tax cuts, as shown in the graph below by the Financial Times. Perhaps one of the most interesting lines from the entire article is the following: A quarter of the UK’s government debt is index-linked, so the cost of servicing it is pushed up by inflation, which is running at a 40-year high.
The entire UK goverment debt will increase with increasing interest rates but if the central bank do NOT increase interest rates, 25% of their debt will increase along with the increase in inflation (which can soar if you do not raise rates and slow down the economy). ”However, soaring prices are now pushing up public expenditures including state pensions, public sector pay and the value of most benefits. Prolonged high inflation also limits economic growth, affecting receipts.”
So in order to keep any money after expenses to pay for your interest, you would want your inflation to not get out of control by raising rates, which will increase your interest payments on your debt. But if you do not raise rates, you let inflation run wild and therefore also lower your budget. The market seems to have picked up these pain points as well, as the British Pound literally took a deep dive before the Bank of England intervened.
Although macro-economic talks sometimes seem complicated, there are actual real-worlds consequences as UK citizens experience an cost of living crisis not seem before in recent decades. Not only do people feel the burden of their increasing energy bill (inflation) which leaves them less room in the monthly budget, they are now starting to experience a further increase in expenses due to rising interest rates.
MORE ON CURRENCIES
I think there are as few graphs that depict the current global currency crisis as the graph on the right. The dollar is gaining strength while other major currencies in the world tumble against the dollar. From a recent Forbes article: ”The U.S. Dollar Index, which measures the greenback against a basket of other currencies, is up nearly 17% so far this year. The dollar’s strength is even more pronounced when compared to the poor performance of stocks, bonds, real estate and cryptocurrencies—and that’s before considering the impact of inflation”.
The most important takeaway from that article, is the following:
- A strong dollar refers to the relative value of dollars compared to another currency or a basket of currencies. A currency isn’t strong or weak on its own; it can only be so compared to something else.
I want you to read that bullet point again. Although the dollar seems strong, the dollar is only gaining strength relative to other currencies as the purchasing power of the dollar itself also weakens due to inflation. Please also remember that the loss in purchasing power due to inflation is lost forever. As described in the first edition of The Perfect Storm for Bitcoin, the dollar simply is doing the least worse of all major fiat currencies.
But the strength of the dollar is now starting to pose serious issues towards other nations around the globe, as the most vulnerable face the biggest blowback. Poor countries often have no choice but to repay loans in dollars, no matter what the exchange rate was when they first borrowed the money. These poor countries need more and more units of their own currency to repay the loans in dollars, as seen in the graph above. Yet again, as seen in our paragraph on the UK at the beginning of this article, the Federal Reserve has no choice but to increase interest rates in order to combat the growing inflation problem. Despite the pain a strong dollar is causing, most economists say that the global outcome would be worse if the Fed failed to halt inflation in the United States. The NY Times writes: ”At the same time, the sweep of rising interest rates around the globe is causing concerns that central bankers might move too far, too fast. The World Bank warned this month that simultaneous interest rate increases are pushing the world toward a recession and developing nations toward a string of financial crises that would inflict “lasting harm.”
MORE ON GOVERMENTS
Recently, we learned that the inflation in The Netherlands has spiked towards an unreal 17.1%, YoY. Such inflation rates are only to be expected in ”third world countries”, or in the Weimar Republic with their hyperinflation. It is yet another sign that our modern problems also require modern solutions. The Dutch goverment still has no real clear solution towards the growing energy prices, inflation and the cost of living crisis. It is now estimated that close to 15% of the Dutch households will experience alot of troubles in paying their bills.
”Winter is coming” for Europe and if their gas/energy reserves are insufficient, this is only the beginning of the energy problems in the continent. With their citizens facing more and more problems and growing poorer and colder with each passing month, the leaders of the EU still have not achieved consensus on their package of solutions. As EU countries spar over gas (and energy) price caps, many economists have already stated that price controls do not control prices. From Fisher Investments for example:
”Why are price controls such a bad idea? They distort price signals, which are core to markets’ functioning effectively and, not unrelatedly, economic growth. Prices balance supply and demand, coordinating production and consumption. Another article from (1991): ”Price controls do not control prices.”
The European politicians have created this energy crisis by shutting down nuclear power plants and investing in unreliable renewables. They have also created the inflation and monetary issues that trouble their citizens. They were wrong on inflation, they were wrong on the energy crisis but yet again, we must trust them to be the solution to their own created problem. The focus on renewables and climate change and the accompying set of laws imposed by the goverments have led to years (perhaps decades) of underinvestment in the fossil fuel industry, creating the shortages in the supply side of the energy equation. For example, Germany is shutting down half of their nuclear power plants, while the Dutch goverment refuses to use their huge supply of gas, therefore contributing to the energy crisis they so hartly seem to fix by imposing more controls that limit the free functioning of the already tight energy market.
A NEW CURRENCY
The Dutch inflation rate of 17.1% as shown above is extended into infinity. What I mean by that is the following: we will not experience deflation to the same extent as we now experience inflation. The best case scenario is for inflation to come down towards the ECB goal of 2%, but this will still lead you to lose 2% of your purchasing power each year. People seem not to understand that prices will not go down towards levels pre-covid ever again. The loss in purchasing power is forever.
Bitcoin has lost 58.63% of its value from YTD. But the thing is, Bitcoin can go up again in the future. If you hold long enough, you loss in purchasing power might be only of a temporary nature. For the first time in history, we are starting to see media articles citing Bitcoin for its relative strength in the past couples of months. For the past 3 months, Bitcoin returned -1.35% against the dollar, while the Euro returned -5.98% against the dollar. Bitcoin is outperforming the Euro in one of the greatest financial crises. Read that again.
The relative strength of Bitcoin amid the currency collapses seems to be acknowledged by multiple sources in the recent months. As the Business Times states: ”Bitcoin Steady as currencies around the world tumble”. The New York Times: Currencies around the world are tumbling. Except Bitcoin. Finbold: Investors ditch the euro and pound for Bitcoin in record numbers as their value plummets.
People around the globe now have an option to opt out of all this goverment induced trouble, as they are now able to use and store their wealth in unconfiscatable form of money that is not controlled by any goverment or central third party. People, now have the option to use Bitcoin, a peer-to-peer decentralised network. A type of digital currency in which a record of transactions is maintained and new units of currency are generated by the computational solution of mathematical problems, and which operates independently of a central bank. People now for the first time in human history, have the ability to store value in an asset that cannot be confiscated by goverments and is freely transported across the world, that does not care about your race, or sexual preference.
In this edition of ”The Perfect Storm for Bitcoin”, we touched upon the factors of the global economy that brought us to the point where we are now. In the following edition, we will further examine how Bitcoin can be a solution and bring value to consumers, savers and people around the globe.
To be continued….
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Eurykleia Investments is not a registered investment, legal or tax advisor or a broker/dealer. All investment/ financial opinions expressed by Eurykleia Investments are from the personal research and experience of the owner of the site and are intended as educational material. Although best efforts are made to ensure that the all information is accurate and up to date, occassionally unintended error and misprints may occur.
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