Photo illustration: Intelligencer. Photo: Leon Neal/Getty Images
Major stock markets in the US fell again on Monday – not only marking new yearly lows, but the Dow Jones closed below the pre-pandemic high reached in February 2019. Poorly? Yes. But even more worrying is what happened about 200 miles south of the New York Stock Exchange at the US Treasury Department. Officials there held auctions to sell bonds that pay for the federal government’s continued operations. The price of these bonds helps determine everything from credit card interest rates to monthly mortgage payments, and serves as an indicator of how bad inflation will get. The auction made it clear that investors as a whole do not believe that inflation is anywhere near over.
According to today’s auction results, inflation is not only expected to remain high next year, it’s likely increase in the next two to three years. As of Monday afternoon, bond investors appear to believe that annual US inflation will remain above 4 percent on average through 2029. That’s double the Fed’s target of about 2 percent — something Wall Street has widely assumed was happening before too long.
It’s not just the US – bad news has been everywhere in financial markets lately, almost regardless of country, region or asset class. Everything from American equities to emerging market currencies to gold and oil has fallen in value. After a tremendous week of global disruption, the world has slowed down to prepare for a stranger and longer period of economic realignment than seemed likely a month ago. Central banks, governments and investors alike are trying to figure out just how bad inflation will get, if the world is headed for a nasty recession, and how bad the financial hangover from all the lavish pandemic-era spending will be.
The UK has been among the hardest hit in recent days – and again inflation is at the heart of the problem. Last week the UK government announced it would blow up its own budget with a series of tax cuts and spending plans to curb absolutely insane energy costs there, causing the pound to slip to its lowest level since the 1980s. Then, on Monday morning, things got even worse. The currency fell to an all-time low against the US dollar – down to $1.03, compared to more than $1.40 last year – and there seemed to be no real plan to deal with the impact . The UK economy has been under pressure from rising prices, similar to the US, although the UK situation has deteriorated significantly due to rising energy prices (energy bills have been forecast at £3,500 a year for a typical household). Prime Minister Liz Truss’ economic plan is a relic of the 1980s, when Margaret Thatcher and Ronald Reagan ruled on promises that the government’s austerity measures would pay off. (A Goldman Sachs research note points out, of all things, that Reagan’s 1981 tax cuts were later reversed because they actually didn’t pay off). There were rumors that the Bank of England would step in to make up for Truss’ wastage by raising interest rates, but that turned out to be false, a decision that sent the pound back to near its lows and confirmed it – in the judgment of Bond Investors – The UK has been less trustworthy in repaying its obligations than Italy or Greece.
Britain keeps precious little money in its central bank vaults to defend its currency – remember this was a problem for Russia when the world cut off its foreign exchange reserves and prevented it from supporting its own currency after economic sanctions were imposed it for his invasion of Ukraine. Despite all of Boris Johnson’s antics, Truss’s predecessor had plans to raise taxes, and her Tory leadership rival had warned that tax cuts would only fuel inflation. Now the British people are left with a weaker currency and the likelihood of larger interest payments on the national debt.
Meanwhile, the Eurozone is doing just as badly, with economic and geopolitical turmoil unfolding in unpredictable ways. Italy’s election of an unpredictable fascist-sympathetic prime minister, Giorgia Meloni, only makes things wilder. A very Tucker Carlson-like speech Von Meloni has been doing the rounds on Twitter, but what may be more crucial for the future is how she is leading a right-wing coalition in negotiations with the European Central Bank, the ultimate authority over continental Europe’s finances. Meloni hasn’t pushed for a Brexit-like break with the rest of the eurozone, but she could negotiate with Brussels to ease funding requirements or urge the ECB to buy more Italian bonds than, say, Germany’s — which all add up deepens investor uncertainty (and pessimism) about the state of Europe and the euro (today it’s trading at 96 cents, down from its recent high of $1.25).
And then there is China. After spending about $1 trillion on its neo-colonialist Belt and Road Initiative, in which Xi Jinping’s government is funding resource extraction and infrastructure projects around the world, the country is slowing its expansion ambitions as its economy goes sideways. China is in the midst of a housing crisis that has been unfolding for about a year and homeowners are refusing to pay their mortgages. Ultimately, this means that the planet’s second-biggest economy is cutting off outsiders’ money while trying to shore up its own finances.
The reality is that within a few short years the world didn’t have more money than it knew what to do with, but rather a huge chunk of it was sucked out of the financial system by central banks with the Federal Reserve pioneering it. Under these circumstances, what happens when the global financial system is starving for liquidity and inflation is still running hot? Stay tuned!