Suffering A Sea-Change

There is an established theoretical relationship between bonds and equities which provides a framework for the future performance of financial assets. It would be a mistake to ignore it, ahead of the forthcoming rise in global interest rates.

Price inflation is roaring, and so far, central banks are in denial. But it is increasingly difficult to see how monetary policy planners can extend the suppression of interest rates for much longer. There can only be one outcome: markets, that is to say prices determined by non-state actors, will force central banks to capitulate on interest rates in the summer.

Hardly noticed, China is deliberately putting the brakes on its economy, which will cause an inflationary dollar to collapse unless the US defends it by putting up interest rates. Deliberate? Almost certainly, as part of its strategy, China is taking the financial war with the US into the foreign exchanges.

Bond yields will rise, with the US Treasury 10-year bond leaving a 2% yield far behind. Equity markets will sense the danger, and it might turn out that the month of May marks a peak in financial asset values — following cryptocurrencies into substantial bear markets.


There is an old stock market adage that you should sell in May and go away. It has already proved its worth in the case of cryptocurrencies, with Bitcoin more than halving at one point, and Ethereum losing 57% between 10—19 May. A sea-change in cryptocurrencies’ market sentiment has taken place.

As for equities, it could also turn out that 10 May, which so far has marked the S&P 500 Index’s high point, will mark the beginning of their decline. But it’s too soon to tell. However, we do know that following the unprecedented dilution of the major currencies’ purchasing power since March 2020 commodity prices have increased substantially, global logistics are fouled up and consumer prices are rapidly rising everywhere, a combination of events which is bound to lead to higher interest rates. But as is usually the case in times like these, central bankers and market bulls are wishing this reality away.

Only last week, the Federal Reserve Board told us that:

“The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer‑term inflation expectations remain well-anchored at 2 percent. The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved.”

Two percent, two percent, two percent, and two percent. Clearly, the world’s most powerful monetary policy planners are willfully blind to reality. In an interview with Greg Hunter of this week, John Williams of, who calculates US CPI on an unadjusted basis, put current price inflation at over 11%.[i] If his numbers are closer to reality, a huge interest rate shock is being stored up, likely to hit markets without much warning.

Central banks are always reluctant to raise interest rates and consequently are horribly wrong-footed. Not mentioned in the Fed’s statement quoted above is the $120bn monthly QE stimulus still inflating financial bubbles and which are feeding yet more inflation into the system. Furthermore, the Fed cannot stop inflating. Unless interest rate suppression and QE are abandoned the certain outcome will be hyperinflation. Arguably, the dollar is on that path already and its purchasing power is early in the process of collapsing.

The notion that maintaining the QE stimulus and interest rates at zero is to help the economy is poppycock. The Fed has two unwritten objectives that override the economy: to fund a free-spending government as cheaply as possible and to keep the bubble in financial assets inflated. Therefore, it cannot afford to consider the horrors of raising interest rates and to reduce the monthly money-pumping, the objective of which is to keep blowing financial bubbles. In these circumstances, markets themselves, being the collective pricing of everything by non-government actors, will eventually force control over financial asset prices away from government agencies.

Non-government actors include both foreign and domestic investors, and they need to be considered separately because their motivations in important respects are different. According to the US Treasury’s TIC statistics, foreign ownership of dollar-denominated financial assets and bank deposits total $30 trillion and are one and a half times America’s GDP. The private sector element alone is $22 trillion. If the dollar’s trade-weighted index is any guide, it may be just beginning to dawn on this class of investor that the dollar is losing purchasing power, not only measured against industrial commodities and raw materials but against rival currencies as well. An over-owned dollar has been falling for over a year and will slide lower when foreign interests start to liquidate dollar financial assets in earnest — and that includes equities.

So far, other than commodities they may not see another currency that offers clear benefits over the dollar, but that will change with an inflation-driven outlook. It is also changing with China’s policy of restricting credit creation, a monetary policy starkly at odds with those of reflationist Western governments.

It was William Shakespeare who came up with the phrase “sea-change” as a substitute for the turn of the tide in The Tempest. The line that followed was “Into something rich and strange”. Bitcoin hodlers will identify with strange. But as for riches, their fortunes have changed substantially for the worse. In its reluctance to protect the dollar, the Fed’s rejection of the consequences of its ongoing monetary inflation is teeing up more conventional markets for a similar price outcome to that currently being suffered by cryptocurrencies.

The fallacy of money-printing to preserve wealth

The empirical precedent about to how to destroy a fiat currency by pursuing monetary policies to inflate asset values was given to us by John Law, the proto-Keynesian who, in 1720, tried to sustain his Mississippi bubble by printing money. Thanks to the dominance of the US dollar, the Fed is repeating Law’s policy on a global scale, seemingly oblivious to the consequences. In 1720, Law’s company survived, though the Mississippi venture’s share price collapsed from a high of 12,000 livres to about 3,000. What did not survive was the currency, the French livre which in about six months from the bubble top became completely worthless. It would seem the Fed and other central banks are now locked into a modern, global version of the John Law experience.

Those who have yet to understand why markets and the dollar are set to fall together should consider how things will develop from here. Without a doubt, financial markets have become wildly overvalued, and their future is becoming binary but with both outcomes being negative. Let us assume the optimists are correct about a post-lockdown sustainable spending recovery. In that case, interest rates will “normalize”, bond yields will rise, and equity valuations will be undermined. Every bear market in a normal credit cycle evolves out of these conditions.

Alternatively, let us assume that the post-lockdown recovery is hampered by rising prices, the consequence of lack of production to satisfy spending inflated by monetary means, and the inability for this imbalance to be rectified by just-in-time manufacturing policies at the mercy of the greatest global logistic foul-up ever recorded. Add to that a shortage of bank credit to finance production, because banks have run out of balance sheet capacity.

Both outcomes will see financial values undermined because in common they lead to higher price inflation and inevitably to higher interest rates. But the Fed and its confrères at the ECB, the BoJ and the BoE are all committed to keeping their bond and equity bubbles continually inflated. The first sign of an inflation crisis can result in only one response: inject yet more money into financial markets to keep them afloat and to compensate for a reluctant rise in interest rates. If the central banks fail to increase the pace of monetary inflation targeted at financial assets, bond yields and market interest rates will continue to rise, and the equity bubble will burst. With no option but to continue to support markets and their wealth effect, a rise in the natural rate of interest simply leads to an acceleration of monetary inflation. A vision of the 1929-32 Wall Street crash will haunt policymakers if they don’t act quickly enough to supply the extra currency.

For the fact of the matter is that using monetary inflation to rig markets requires accelerating debasement to keep the illusion going. But at best, the sacrifice of the currency only delays matters temporarily. This is what Richard Cantillon, the Irish-French banker contemporary with John Law worked out in 1719: the most certain way to profit from a bubble’s implosion was not to short it, but the unbacked currency, which he did in London and Amsterdam for specie-backed alternatives.

Today, there are no specie-backed alternative currencies, the backing for all of them being the US dollar, which faces the same fate as Law’s livre. Another important lesson from the fallacy of money-printing to preserve wealth by inflating financial assets is that it does not take an incremental and accelerating loss of purchasing power through a policy of continual debasement to undermine the currency on a formulaic basis as monetarists would suppose. Instead of initially being driven by rising prices for goods and services the collapse of currencies is linked initially to that of financial assets, less so than to the prices of goods. Instead of an evolutionary process it has the potential to be much more sudden, tied into an overwhelming stock market collapse.

While events run concurrently, it is after a financial crisis that the principal users of a collapsed currency, its domestic actors for their daily purchases, suffer the full effects. Not only do they see prices of essentials rising, which they might mistakenly attribute to the preceding financial crisis, but interest rates rise as well. Mainstream economists will tell everyone that higher interest rates are reducing demand, and without more stimulus businesses will fail in even greater numbers. Inflation, by which they mean increasing prices, will only be temporary due to falling demand and they urge the authorities to maintain and even increase the rate of money creation to boost the economy and stop it from entering a slump.

What economists, investors and the ordinary person fail to understand until too late in the process is that the problem is of a collapse in the purchasing power of an unbacked state currency, which requires a completely different solution. That oft-quoted phrase about fiat money reflecting faith and credit in the government means something after all.

After the foreign holders have sold out, it is the actual users of a currency, who pay for their consumption with it, that are last to realise the currency is set to collapse entirely, and that they should get rid of it for anything they can buy. This eventual outcome is certain, so long as the central bank continues with its inflationary policies.

It is at this endpoint that the economy experiences a crack-up boom. When and if they can afford it, people even buy equities and property, simply to get out of fiat currency. But both these classes of asset will have fallen substantially measured in a rapidly depreciating currency before this condition has arrived.

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Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not reflect those of Goldmoney, unless expressly stated. The article is for general information ...

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