With interest rates rising in Powell’s “higher for longer” war against inflation, the net result, ironically, will just make inflation go equally “higher for longer” as the Fed slowly but surely loses control over interest rates and unpayable debts.
With US public debt fast approaching $33T, the cost of that debt in a rising rate environment only becomes higher (and more unsustainable) unless the Fed monetises the same with more mouse-clicked liquidity, which is, well…inherently inflationary.
Even the St. Louis Fed recognised the irony/dilemma of this vicious debt circle in a June, 2023 white paper, an irony they described as “fiscal dominance” by which fighting inflation leads to more inflation.
UNCLE SAM’S UNLOVED IOUs
Ultimately, the bond market, rather than central banks, get’s the final say on rates. Throughout 2022, foreign interest in USTs tanked, while foreign central bank stacking of physical gold reached record highs. This trend, in fact, has been in place for nearly a decade…
This is no coincidence, as an increasingly expensive and now weaponised USD has forced other nations and economies to either look outside the USD or dump current UST holdings for needed liquidity. Naturally, the slowing foreign demand for Uncle Sam’s IOUs puts downward pressure on UST pricing and upward pressure on yields—and hence interest rates.
In order to fill this supply and demand “gap,” we will likely see an eventual return/pivot to QE to provide needed liquidity (and artificial demand) into an otherwise zombified UST market.
THINGS ARE BREAKING
In the interim, things have continued to break under Powell’s hawkish rate hikes. As USTs fall in price under Powell’s watch, banks which hold those bonds as collateral have been falling off the vine one by one since early 2023. We don’t think this process has ended.
Smaller businesses, struggling to extend and pretend or refinance under a rising rate policy are also declaring bankruptcy at an increasing pace.
Net result? More layoffs
Meanwhile, the folks on Main Street are defaulting on car and credit card debts with equal gusto. In short, and as warned, Powell’s alleged war on inflation via rate hikes was destined to break things, and this process, from Wall Street to Main Street is far from over.
THE RED DEBT BALLOON
The simple yet sad fact is that credit markets are akin to a giant red balloon surrounded by a wide number of needles. Any number of known or unknown “credit events” could trigger a national or even global credit catastrophe in the coming months.
Take for example, the Japanese “carry trade.” US institutions (banks, hedge funds, bond jockeys etc.) are always looking for cheaper costs of debt to then lever into (hopefully) higher turns of margin and “reward.” Of course, with reward comes risk, something no one in the over-paid trading pits want to see.
Toward this end, Japan, with its historically low rates, has been a source of Wall Street risk as investors borrow at the cheap from Japan and then lever that cheap capital to the max in US market bubbles.
FROM BUBBLE TO NIGHTMARE
This game of rate and currency arbitrage works well when the borrowing rates are low, but can turn into a nightmare if those rates suddenly rise by even a small amount, as even a 10-25 basis point spike can spell disaster in a backdrop of extreme leverage, which is what Wall Street does best.
For those paying attention, however, Japan has been hinting at a possible rate hike to address potential inflation risks emanating from more Yen creation to pay for higher energy prices. Any overnight change in BoJ rates could unwind levered credit markets in the US and beyond.
But this is only one potential yet largely ignored needle pointed at the record-breaking US debt balloon.Often, markets implode for liquidity reasons no one sees coming; but even the visible risks now are rising as that red balloon gets fatter and fatter.
BRICS HEADLINES OR HYPE?
For now, however, the headlines are primarily focused on the potential announcement of a gold-backed trading currency among the BRICS at their August summit in South Africa. We were among the very first to warn of the obvious and inevitable de-dollarisation process to emerge from the absurdly myopic policy of weaponising the world reserve currency in the form of a Putin sanction which would ultimately be a shot in the Western foot.
Now, over 41 nations tired of an expensive and weaponised USD are reaching trade deals outside of the USD. In short, we are not surprised nor phased by the irreversible trend away from the Greenback. Indeed, few could be more cynical about the ultimate trajectory of the Dollar’s declining hegemony and demand in the years ahead.
Despite such little faith in the Greenback, we are nevertheless surprised by all the current hype around a sudden “gold-backed trading currency” poised to dethrone the USD by year end. Don’t hold your breath.
Even the Russian Central Bank has confessed that such an event (the mechanics, the gold reserves etc.) would take years not days. And even the BRICS spokesmen themselves have been saying that a gold-backed trading currency is not even on the August agenda.
THE USD STLL HAS A LITTLE LIFE
Furthermore, and however discredited the USD has become, it is still (in the form of USTs) the primary collateral for the Euro Dollar and derivative markets to the tune of trillions and trillions.
In short, the USD will not end overnight nor in South Africa. Yet as previously alluded, the ultimate trajectory of the fiat USD is anything but good.
Like all paper money throughout history, it will revert to its intrinsic value of zero. We are simply arguing that the magnitude and speed of this trajectory has been sensationalised of late.
REALITY IS SENSATIONAL ENOUGH
In point of fact, there’s no need for such sensationalism when the facts already on the ground are sensational enough. The very fact that US and UK sovereign bond markets have neared implosion since October of 2022 is scary enough.
The fact that four major US banks and one massive Swiss bank effectively died in 2023 is scary enough.
The fact that Main Street Americans are delinquent on debt after debt after debt is scary enough.
The fact that commercial real estate vacancies in cities like Miami and Dallas are over 20% vacant is scary enough.
Finally, and perhaps most importantly (as well as openly ignored by most), the fact that Saudi Arabia will be joining the crowd at this month’s BRICS summit is far more alarming as a threat to the USD than the current hype about a new gold-backed trading currency.
THE HIDDEN SAUDI THREAT
Saudi Arabia could very easily tire of a Petrodollar system backed by an increasingly unloved and over-indebted USD. We are a long way from the early 1970’s when the UST was yielding a real rate of 8% and the US debt levels were well below $500B rather than the current $33T. After all, oil sales based on USDs rather than gold have been nothing but volatile since Nixon closed the gold window.
Hence, the fact that more and more oil may eventually be sold outside of the USD is scary enough indeed.
MORE BREAKING TO COME
Equally sensational, is the undeniable fact that there is much more breaking to come, especially from an over-stretched derivatives market priced in the quadrillions and just waiting to pop under the pressure of rising leverage costs.
Thus, and to repeat (and as repeatedly warned), things are already breaking at a sensational pace due to broken credit markets and drunk driving at a cornered Fed. Chaos in credit, currency, equity, real estate and global financial markets is not just coming/looming, it’s already here.
And given that gold loves chaos, dying currencies and broken, debt-soaked regimes, we couldn’t be more comfortable in the one monetary metal that can’t be created at will. EG