Achtung! Watch Out! Interest Rates & Inflation

The price of everything is going up and this is not a forecast – it is happening now! Our central banks and governments are handing out cash that must be repaid at some time in the future. In particular, the actions of the Central Banks are resulting in large price hikes and they will be evident soon alongside tax increases just when taxpapyers are asked to repay these debts through taxation. And while this is going on bankers are enjoying record profits and will continue to do so thanks to the central banks who are printing money like never before…

This money is being created by electric printing machines. These are not real printing machines that are used to make newspapers and magazines. The machines are part of a huge global network of powerful computers, and at the top are governments of America, China, Japan, the European Union and a few member states. They are all issuing bonds through big banks who are then meant to sell these bonds to long-term investors.

Long-term investors relegated to Second Division

These investors are insurance companies, pension funds, investment funds, hedge funds, sovereign wealth funds, companies with spare cash to invest, banks and a huge number of rich private investors and their family offices. They normally buy and hold for long periods of time.

They are important, but their position in these markets has now been relegated to the second division. New groups of actors now dominate the government bond markets with strange games that are played out on a dark stage well away from the bright lights of public scrutiny. We will never really know much about what is going on between them.

Short-term Buccaneers now Dominate with Punch-Drunk Central Banks

These new more dominating groups are a few huge banks that dominate the primary and secondary markets in government bonds. The second group are central banks with their QE policies (see below) and the third group are a bunch of hedge funds and high frequency traders (HFT) who buy and sell billions of government bonds as short term for short term trading profits.

  • Their activities are interconnected and interdependent:
  • They buy and sell huge amounts of these bonds with each other.
  • They help to provide finance for these trading portfolios.
  • They use the same software and private networks.
  • They even change jobs from one group to another.

What most people fail to understand is that the general population can end up paying for the buccaneers’ actions, for bad policies, and poor risk management for decades with huge amounts of our hard-earned taxes.

US Banks – Too Big to Fail

The first group are the few huge banks (mainly American) that dominate what we call the primary and secondary markets for government bonds. They are “committed” to buy these government bonds and distribute them to “investors” and “maintain an orderly secondary markets”. They operate like natural monopolies and get paid for this service either with a tiny percentage fee based on huge turnover or on the difference between the buying and selling prices. They live well and seldom complain about losing money. Annual salaries and bonuses are normally in the millions for decades in good and bad markets!

Central Banks – The Elephants in the China Shop

The second group are the central banks who have committed themselves through a policy called Quantitative Easing (QE) to reduce the impact of the financial crisis and Covid19 by keeping interest rates low. Interest rates have been near to zero for almost a decade through massive purchases of these government bonds from the above big banks. The size and impact of these purchases have never been witnessed before in mankind’s history and they have enriched a few bankers’ pockets. The amounts are in the trillions of Euros and Dollars and have resulted in buckets of cash being thrown into the banking system and into our economies that is now causing inflation.

Price inflation starts with is massive flow of cash into the economy and when investors stop buying bonds because of their low returns and start buying shares and real estate. Equity prices shoot up just like house prices… and the inflationary story does not end here.

As time passes inflation pushes up interest rates – the price of money – meaning that house owners pay more for their housing loans.

Then we have Covid19 that has caused a slowing of our economies. Staff are laid off, some jobs disappear, and companies face liquidity problems. Our governments have now stepped in to provide massive cash financial support for companies, employers and workers who have lost their jobs. The government’s logic is that it is better to grant financial support rather that seeing companies going bankrupt.

However, as Covid19 slows with new vaccines things will get back to normal and the pent-up demand fuels a boom of buying. Prices of raw materials, fuels, shipping costs will be seen earlier rather than later leading to demands for wage increases and tighter labor markets. We are already seeing price increases of food, raw materials and oil.

Hedge funds and HFT – Scary

The hedge funds and HFT care nothing about why the government bonds are issued – they just speculate with huge positions for tiny percentage profits using highly sophisticated software that searches automatically for small price discrepancies. They receive important liquidity and financing from the same big banks because they generate important profits for the banks through trading volumes and financing. Most of them are speculating that interest rates will rise and nothing can stop that happening if they decide to take on such positions. They provide no useful end for the real economy in which we ordinary folk live.

They create income inequality and the regular financial crisis when one or two of them gets it wrong… they are traditionally “too big to fail”.

Finally, senior bankers get nice jobs as governors of central banks, finance ministers and even prime ministers. Former political leaders also end up with plum jobs in banks – the list is long and wonderful. So even when you have sucked the juice out of the orange you then get an orchard to farm.

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