Today’s world is a mass of disorder.
And the world is flooded with money.
One of the things I’ve been emphasizing over the last decade or so is how the western world generates debt and supports debt issuance through central bank debt purchases.
Actions like this create bank deposits…money.
One current piece of evidence on this fact is presented by Laurence Fletcher and Chris Giles in the Financial Times.
They inform us that from March 2009 to June 2022, the Bank of England buys 57% of the £1.5 net gilts sold during this period.
Additionally, it is well known that from early January 2020 to early January 2022, the Federal Reserve added $7.1 trillion of directly purchased securities to its portfolio.
As I wrote above, the world is awash with liquidity injected into the financial system by the policies followed by central banks around the world.
And now what do we face?
Inflation. Lots and lots of inflation.
And, people are surprised.
Inflation in Europe and England
One can take a look at Europe and England to see what a mess the world has gotten itself into.
Germany has been facing a 40-year peak in inflation.
In August, the inflation rate was 8.8%.
Inflation is the highest in the European Union since the introduction of the euro 23 years ago.
Currently, it costs $1.00 to acquire a euro parity.
In Germany we see all the money created by the European Central Bank in the last two years and we also see Germany experiencing gas and electricity shortages.
Germany is also facing higher food prices due to shortages.
Well, you can say that the Ukrainian situation, with the invasion of Russia, causes problems.
Yes it is.
And, with all the money circulating in Europe, it is no wonder that prices are rising.
At present, it is expected that the European Central Bank will begin to reduce its balance sheet by the end of the year. Discussions are expected to start in October.
However, analysts have suggested that the European Union could hit double-digit inflation before price increases return to a more manageable level.
With Belgian inflation at 9.9% in August, close to a 40-year high, and Spain posting an inflation rate of 10.3% in August, the euro zone should reach an inflation rate historically high above 9.0% in the figures to be published. Wednesday.
And, in England, one could say that things are even worse.
The Bank of England has suggested that England is in the middle of what will be a 15 month recession. Inflation could rise to 13%.
Fischer and Giles, in the article quoted above, report that Goldman Sachs analysts suggest that “UK inflation could exceed 20%.
It has been suggested that the Bank of England could push short-term interest rates up to 4.2% next year from 1.75% currently.
So the world is flooded with liquidity and the supply conditions in the world are turned upside down, if one can use that word to describe the situation.
In this world, inflation is not a transitory phenomenon.
It’s a global problem.
Because central bankers thought the inflation they were seeing was a transitory phenomenon, they did not act soon enough to tackle the problem.
And, it seems to me that every central bank in the world is “behind” in solving the problems they currently face.
Central banks are “behind the curve” and most of them, including the Federal Reserve in the United States, are beginning to realize that they are “behind the curve” and need to take significant action or, at least, relatively large ones by significantly increasing their key interest rates and shrinking their balance sheets.
If everyone jumps on the bandwagon and takes meaningful action to reduce their own inflation problems, then we could see a significant withdrawal of liquidity from financial markets.
It wouldn’t be good.
Looking at this situation, I can see central banks raising their key interest rates, but I don’t see them making major reductions in their balance sheets.
The reason for this is that most central banks do not recognize or admit the fact that they overreacted to the spread of the Covid-19 pandemic and injected far too many bank reserves into the banking system. in 2020 and 2021.
This is a major concern of Mohamed El-Erian, who wrote a major article on the current central banking dilemma in the Financial Times on Monday morning.
By not accepting the mistakes made during the 2020-2021 period of monetary expansion, the Federal Reserve and other central banks are unable to undo some of the actions that were taken then.
Mr. El-Erian believes that central banks need to observe, absorb and come to terms with the fact that some things that were done during the critical period of the pandemic need to be reversed.
And that answer could end up being a bigger job than many central bankers are willing to take on.
Policy makers face a huge problem.
Perhaps the biggest component of the problem is global inflation which has now taken over the globe.
But, the monetary issue is simple: as noted above, the world is awash with cash.
Central banks must step up and admit the excessive injection of money into the global economic engine.
While at the time the central banks were pumping all the money into the banking system, they wanted to make sure that they always erred in monetary excess. And, they did.
But now is the flip side. There is far too much cash in the world.
And inflation will be guaranteed by this money.
So, sooner or later, central banks will have to “shrink” cash balances.
Yes, central banks are going to have to raise interest rates.
But, let’s say the Bank of England raises short-term interest rates to 4.2% and inflation is in the double digits.
Is this a “restrictive” interest rate?
It seems to me that the real interest rate is still in negative territory.
This, the Bank of England will have to overcome.
The fact is that inflation is not just a problem in the United States.
And it’s not just a problem for the Federal Reserve.
This only increases the complexity of the world out of balance I have tried to draw attention to.