Everyone is now watching long-term government bond yields going through the roof, from Japan to the UK, from France to the US. A few months ago, Wall Street’s analysts’ expectations, along with those of many other “experts” (that I am not sure how they can be defined as such, considering events proved them consistently wrong over and over again through time), were quite different and broadly expected interest rates to come down instead. The same happened in 2024: “The Fed Will Cut Interest Rates (Six Times!) in 2024, According to Wall Street.” And prior to that, in 2023: “Fed’s No-Rate-Cut Mantra Rejected by Markets Seeing Recession“. What are all these people missing and, as a result, continuing to misread market dynamics? We are now in a high-inflation environment.
Hold on, isn’t inflation under control and coming down across the globe except for Japan (more on this soon), according to official data? This time around, instead of boring you, my dear reader, once again with the argument of fake BLS and other agencies’ statistics, I would just like to present you with this meme I came across on the internet, which I believe is the best visual summary of what has been going on for years and that now traders don’t take at face value anymore.
Current inflation and future inflation expectations are critical elements to understand what the hell is happening in fixed income markets, especially government bonds. Be careful not to make the mistake of only considering consumer price inflation instead of considering monetary inflation as a whole. Why? Consumer price inflation is only one of the various release valves through which monetary inflation manifests itself. Furthermore, considering how globally interconnected the world financial system has become today, it is wrong to consider the money supply of single economies in isolation. Why? Simply because money can criss-cross the world from one economy to another with limited, if not nonexistent, frictions nowadays. The JPY carry trade is a great example of this dynamic, showing how JPY currency printed out of thin air by the BOJ for decades, instead of remaining within the country’s borders, kept flooding foreign markets instead. As a result, Japan’s domestic stocks and consumer prices saw limited impact from all this flow of currency over decades; meanwhile, foreign asset prices were inflated due to purchases financed with JPY. As you can see from the chart, the global M2 money supply continues rising, non-stop, without any sign of slowing down.
What are government bonds? In practice, they are simply fiat currency claims postponed into the future. If investors in government bonds expect more and more currency will be printed in the future, do you think they will not adjust their demands to be compensated more and more? Of course, they will. However, there is a very important element they also consider: the likelihood of being repaid in full.
Hold on a second, how is it possible for a government whose central bank can print infinite currency out of thin air to monetize any deficit spending and debt refinancing, not to be in the condition to repay its own government bonds that, as I said before, are nothing more than fiat currency postponed into the future? Because the assumption that a central bank can print an infinite amount of currency without consequences is simply WRONG. If you visualize cash as a government bond with a zero interest rate and zero maturity, it will be easier to understand what I just stated. If you assume a government can print infinite currency without consequences, then you also have to assume it can carry infinite debt without consequences. But mathematically, what is the real value of a unit of currency if the total supply goes to infinity? The result is: ZERO. Who’s willing to lend money to a government when the expectation is to receive much less (in real economic terms) in the future? No rational thinker will reply “Me!” to this question. As a result, the whole attempt perpetrated by the governments of developed countries all around the world for decades to “inflate their debts away” rather than repaying them is now backfiring spectacularly. There is no better example of the disconnect between the world of economists basing their research on completely wrong assumptions, theories, and data disconnected from reality than this paper that was literally presented 2 weeks ago during the Jackson Hole central banks’ yearly meeting: “US Debt-to-GDP of 250% Won’t Push Up Rates: Jackson Hole Paper“. Clearly, traders aren’t sucking up this garbage anymore.
Is what I am describing an isolated case or a broader one?
- The most recent year France recorded a government budget surplus was 1974.
- The most recent year the UK recorded a government budget surplus was 2001.
- The most recent year Germany recorded a government budget surplus was 2019.
- The most recent year the US recorded a government budget surplus was 2001.
- The most recent year Japan recorded a government budget surplus was 1992.
- The most recent year China recorded a government budget surplus was 2007.
OK, maybe it’s easier to take a look at which developed economies’ governments managed to close their 2024 budget with a surplus: Norway and Denmark. Yes, only two, not even Saudi Arabia, which is sitting on biblical US oil wealth, managed to avoid closing 2024 in a deficit despite the flood of revenues it is blessed with.
Yesterday, one of my followers argued that when the current stock bubble bursts, investors will be forced to buy government bonds again. Furthermore, he claimed, long-term yields are not a major problem for government refinancing that is mostly done with short-term T-Bill notes whose yields are highly influenced by the Fed Fund rates. What he said, I am sure many out there share his view, has been true for a long time. I do not disagree, but it is wrong to assume it will continue to remain the case when the structure of the economy, now in a high inflation environment, is dramatically different. T-Bills are simply USD postponed a few months into the future; as a result, skewing the financing of government debt too much to the short part of the debt curve will simply accelerate currency devaluation. Isn’t this exactly what happened to Japan? Or more evidently in countries like Argentina, Venezuela, or Turkey?
All in all, the whole problem won’t be solved until governments resume repaying their debts, plain and simple. Increasing the amount of debt will have a combined effect on the government’s currency value and cost of debt in different proportions, depending on the composition of its liabilities. If a government tries to limit its interest expenses, the currency will lose purchasing power faster. If a government tries to limit the amount of debt it repays in the future, preferring to postpone it into the future, then yields will rise to reflect that. What happens if the central banks step in, implementing Yield Curve Control and artificially limiting the rise of yields on the long-term part of the curve? In order to achieve that, it will have to print currency today to purchase those bonds from the market and keep a constant bid to put a ceiling on yields. This, of course, will accelerate the present devaluation of the currency. This is literally a doom loop Japan has been through for decades (“A PEEK INTO THE FUTURE: USD/JPY ROAD TO 300“), and yet nobody, apparently, is treasuring that evidence to avoid repeating the same mistakes.
What alternatives do investors have if every single country out there is effectively playing the same game? True, if you look at FX rates between countries, investors seem trapped, and the best investment choice might be to bet on the country that will be the first to put its finances in order in the future so its currency will appreciate, relatively speaking, against others. However, when it looks like nobody intends to put its finances in order anytime soon, the options are limited to alternative forms of currencies like physical gold and silver. Period. This is exactly the reason why gold and silver continue to appreciate dramatically, even outperforming the euphoric stock market, and as a matter of fact, they will continue appreciating in value for the foreseeable future simply because the real value of fiat currencies continues to decrease.
The most striking example of fiat currency collapse is perhaps given by the gold chart against JPY, and I bet many other comparisons in the future will look similar.
I hope today’s article helps to clarify once and for all what’s been happening since, when I did it for the first time long ago, many found it hard to believe my warnings, because markets at that time had yet to metabolize the dynamics that are now in full motion. Here is the list of major articles and podcasts I suggest you take a look at if you don’t want to be taken by surprise anymore by markets:
- THE US YIELD CURVE IS SCREAMING “DANGER!” AND ONCE AGAIN NOBODY IS LISTENING
- WITHOUT THE FED RESUMING QE, THE US WILL FACE A DEBT CRISIS VERY SOON
- FED ACTION TODAY MARKS THE BEGINNING OF THE END OF THE FIAT MONETARY SYSTEM EXPERIMENT
- THE PERFECT STORM IS NOW STARTING TO HIT JAPAN’S FINANCIAL SYSTEM
- HOW TURKEY ENGINEERED ITS OWN ECONOMIC COLLAPSE AND WHY JAPAN AND UK ARE FOLLOWING ON THE SAME FOOTSTEPS
- THE MOUNTING CRISIS IN THE UK FINANCIAL SYSTEM WILL MAKE 2022 LOOK LIKE A BRIEF REHEARSAL
- UNMASKING POWELL’S JACKSON HOLE WARNING AND PREPARING FOR NVIDIA’S MOMENT OF TRUTH
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