It wasn’t the new Chancellor’s tax cuts that drove the pound down, but rising interest rates in the United States that kicked the global economy.
Engineers will be very familiar with chaotic processes. In some particular types of setups, tiny differences in starting points can lead to very different results. Small inputs can lead to giant unpredictable results. Poincaré predicted the trajectories of the planets and won an award, only to find a mistake in his work and realize that he had in fact proven them nearly impossible to predict through what would become the foundation of chaos theory.
It turns out that the economy is one of those body systems in motion and even if you have a theory that works at the moment or maybe a theory that matches the cyclical observations that are going to change soon, things will decouple and pull everyone into a fundamentally changed economic system.
The old joke goes, “If a butterfly from the Sahara can cause a hurricane in the Gulf of Mexico, someone has to find that butterfly and squash it.
Apparently, some people are deceived by chance, but in reality, most have no idea what it is.
Just when one considers the task of running an economy to have been cracked open, another strange attractor kicks in and the rules change enough to produce a crisis.
There is no permanent debugging of an economy; just like a machine, it wears out, goes out of tolerance and breaks.
As I write this in early October 2022, it looks like we are heading for such a crisis event.
Last week, the Bank of England had to step in to save long-term government bonds because they were collapsing. The statement about the use of £4,000 per average family to ‘protect the financial stability of the UK’ was probably misunderstood. After all, a little jitter is a common experience for most people and it’s not that bad. However, what this meant was that the quantitative easing action, whereby the Bank of England had stepped in at a gallop and loaded up bad government bonds to stabilize its price, was to prevent financial Armageddon. . If a country’s public debt spirals out of control, the result is economic devastation.
In the way these stories are told, it was all down to the new UK Chancellor’s plan to try to pull the UK out of a quagmire of stagnation with tax cuts and energy subsidies. It’s a simple explanation, after all that “brave” rhetoric was the lit wallpaper for classic disasters of government economic mismanagement in the past, particularly in the 1970s.
The truth, however, is that the US Federal Reserve announced four days earlier, raised interest rates by 0.75% and said it was going to blow up the US economy to bring down inflation. This put the whole world on notice and on the brink of panic that dark days were ahead.
Here are some excerpts from Federal Reserve Chairman Jerome Powell’s statement and press conference, with my comments in parentheses:
“Nevertheless, we are committed to bringing inflation down to 2% because we believe that a failure to restore price stability would cause far greater pain later.” (This means they will create less pain in the short term.)
“Higher interest rates, slower growth and a loosening labor market are all painful for the public we serve. But they are not as painful as failing to restore price stability and then having to come back and do it, again on the road, and do it at a time when, in fact, people are really expecting high inflation.” (Pain, pain, pain…and it was also made clear that the Federal Reserve was going to ramp up deflationary actions to make sure they worked. They may be lying, but a U-turn would soon be extremely difficult, and it will have to be soon to prevent the various economies and markets from falling into freefall.)
This is the underlying reason why the UK long bond imploded.
The old adage says that when the United States sneezes, the world catches a cold, but the reality is that when the United States catches a cold, the world catches pneumonia. hundred is terrifying. This has created a runaway dollar, which crushes everything, including the pound, in its path.
This runaway dollar is key to what happens next, because if central banks, including the Federal Reserve, lose control of the rising dollar, there will be a full-scale global financial crisis.
At the end of the day, most developed countries are eye-borrowing and continue to spend out of control. To fund this you have to borrow, and when nobody wants to lend, you print the money and lend it out, just like the Bank of England did last week.
By removing the niceties, the government (the Bank of England) earned money to buy government bonds so that it could continue to sell bonds in the future. Selling in the future to fill the gaps will come either from outside or from the government itself via the print media. This increase in the money supply creates inflation and no increase in interest rates will reverse this monetary gravity.
But… but… people say, “You raise interest rates to lower inflation, everyone knows that.” The problem is that interest rates are exorbitant in Turkey and Argentina, as are interest rates in all countries with permanent inflation. You can have high interest rates and print money which creates inflation so it is the increase in the monetary base which creates inflation and that is where the problem lies .
If the politics of the UK, Europe and the US continue to dole out new money to bail out those they believe should vote for them, then the road to ruin is set. To make matters worse, if the Federal Reserve is to be believed, it has set a course to achieve this in the coming months, because it can pull the rug out from under the whole process if it is really ready to inflict pain on the global economy to get the inflation out of the system.
Few notice that disaster is averted, but one is certainly close. If the next few weeks turn into the Federal Reserve against the financially incontinent policies of developed world politics, then we’re in for a very tough ride. If the US Federal Reserve pivots, we are in for a long period of high inflation. The latter seems very likely, but it’s hard to hear the Federal Reserve talking last week and imagine that it can just say, “I’m kidding.”
It won’t take long to find out.
Sign up for the E&T News email to get great stories like this delivered to your inbox every day.