Central Banks Aren’t Powerful Enough to Stop This

demonetization affect on inflation

Right now, we have:

  • Historically challenging market valuations
  • Strong, rising inflation since the onset of 2020
  • Low market interest rates
  • Central banks that would like to raise rates and stop printing money

How do these factors fit together? Let me simplify it for you.

Valuations are Stretched

As my colleague Garrett Baldwin explained the other day, equity markets are currently quite challengingly priced. The S&P 500, for example, currently has a price/earnings ratio of 44.5 for the current year. The historical average is around 15.

If the yield on fixed-interest bonds rises, they increasingly become a competitor to the stock market because the return from them is risk-free. When inflation rises, the market interest rate/yield has to increase because lenders want to earn something on the interest rate after deducting inflation.

Central banks want (or need?) to keep market yields low. Thus, they will ignore the inflation that has recently popped up. Or they will claim that inflation is only temporary and, therefore, loose monetary policy may remain in place.

Americans should pay close attention to what is happening in Europe. Ignazio Visco, the Italian member of the European Central Bank’s (ECB) Governing Council, intends to oppose any rise in market yields in the eurozone.

“Large and sustained increases in interest rates are not justified by the current economic outlook and will be countered,” he recently announced at the annual meeting of the Banca d’Italia. This is important.

Central Banks and Demonetization

Back in March, the ECB had decided to increase the volume of monthly bond purchases even further. Since the beginning of the year, yields on eurozone government bonds had also risen significantly.

Visco also proposed adjusting the ECB’s inflation target. So far, the central bank accepts a monetary devaluation in the eurozone below, but close to +2%. Now it should be precisely +2% if Visco has his way.

But this mark was already reached. As announced this week, inflation in the eurozone in May was precisely this +2.0% in a 12-month comparison. In the previous month, the indicator had still been at +1.6%.

Meanwhile in the United States, the Federal Reserve (Fed) abandoned its target of a monetary inflation rate of +2.0% in August 2000 to “tolerate” even a “moderate” overshoot in the future. For April, a U.S. core inflation rate (i.e., excluding food and energy prices) of +3.0% had been established 14 days ago.

The “true” inflation rate, including prices, which are enormously essential for consumers, even reached +4.2%. Remember, these are the official numbers. So if things are more expensive than what the government is telling you, don’t be afraid to believe your “lying eyes” instead.

Central banks keep interest rates as low as possible to ensure that governments can continue to borrow. They engage in this buying EVEN though this is explicitly NOT part of their tasks.

They do this by buying up as many offered bonds as they can for high billions each month. This is a precise manipulation of this market.

Without this market manipulation, market interest rates would already have been at a much higher level for 14 months.

Why? The otherwise usual repayment guarantee of the creditor states would have become increasingly improbable with the blatant new debt in this short time.

But market interest rates must also remain low because the sheer mass of debt and new borrowing means that the interest burden associated with a rise in yields would simply no longer be sustainable.

Inflation, Market Interest Rates, Manipulation

Based on the developments described above, the cat is biting its tail. Market interest rates are going up as inflation picks up. However, the monthly manipulations on the bond markets are still halfway sufficient to keep them low. The rise in yields in the U.S. since August 2020 – from +0.49% to as much as +1.75% at the end of March for 10-year U.S. government bonds (currently: +1.59%) – took place during the Fed’s bond-buying program.

The same applies in a similar way to yields in the eurozone. This shows you: Central banks are not all-powerful!

The ECB even increased its firepower again in March of this year, pumping even larger sums of euros into the markets. Inflation, meanwhile, feeds on a high money supply, which is matched by comparatively fewer goods and commodities.

As supply chains have become increasingly asynchronous since the beginning of last year – due to the global lockdowns – this squeezes the supply of raw materials, the demand for which cannot be adequately satisfied.

This, in turn, accelerates a rise in prices. It starts at the producer level and passes on through the supply chains to the end- consumer. If, in addition, the costs of wages and salaries rise, as is already the case in the USA, inflation will result, which will also have an impact on the consumer.

So Now What?

The central bank has been running the money printing press since the financial crisis. But so far, for precisely these reasons, we have seen inflation only in the asset classes of stocks, bonds, and real estate.

Central bankers believe they have everything under control. Above all, however, they strive to make market participants think that they have everything under control. But that is precisely the crux of the matter. As soon as the market stops buying into the central banks’ agenda, yields will follow inflation rates – despite all market manipulation.

Everything is likely to get far worse than if the central bankers were now gradually to come to their senses. Because then it will become clear that the gigantic debt is no longer affordable. The bigger story for the markets: the frothy valuations on the stock markets will also burst. I’ll discuss more about ways to protect your money from the fallout.

Dr. Gregor Bauer
Dr. Gregor Bauer
Dr. Gregor Bauer credits his trading success to combining fundamental aspects of a trade with expert technical analysis. A Certified Financial Technician from the International Federation of Technical Analysts (IFTA), he’s rated as one of Germany’s top 300 economic experts.
Dr. Gregor Bauer
Dr. Gregor Bauer
Dr. Gregor Bauer credits his trading success to combining fundamental aspects of a trade with expert technical analysis. A Certified Financial Technician from the International Federation of Technical Analysts (IFTA), he’s rated as one of Germany’s top 300 economic experts.

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