Great Pivot To Loosening
So the great pivot to loosening is in play, which I forecast would happen in June. Staring down the double barrel of a systemic crisis, a sovereign bond crisis, and collapsing GBP, the Bank of England capitulated on September 28 and reverted to buying gilts.
The tightening until it breaks mantra to fight inflation did not take long for the tough-talking inflation-fighting Hawks to step out of the ring as soon as they saw a knockout blow coming.
Why did the pivot to loosening happen sooner than anticipated?
There is no market for government bonds when real yields are negative and there is no way central banks can raise rates high enough to compensate for the inflation that they partly created.
In other words, central banks have become the buyers of last resort buying government bonds, thereby artificially suppressing yields.
We are seeing the transition from free market capitalism to State capitalism. Central banks are bankrolling the state, they have the government in their back pocket. So if you finance an entity you influence directly or indirectly its actions. Central banks now shape fiscal, and foreign policy, they pick the winners and the losers.
It is similar to the former Soviet Union’s planned economic system, where the price mechanism is nonexistent.
What would happen if the great pivot to loosening was further delayed?
So if gilt investors are worried about the rising public deficit and an unsustainable fiscal policy where the government spends more than it receives in tax revenue, they will reassess the riskiness of the investment.
The risk includes sovereign default or the debasement of the currency due to excessive printing. So, if the government defaults on its debts, and becomes insolvent, the investment is completely wiped out. Alternatively, when the Bank of England decides to purchase the gilts, it creates GBP, but if you increase the supply of GBP and demand for the currency remains equal the price of GBP falls, and its exchange value falls.
So currency debasement is the risk of holding gilts, in a situation where the government honors its debt because the BoE does QE.
Imagine receiving your ten thousand GBP investment in 10 years with yields if the total amount on maturity buys you half the goods and services.
The great pivot to loosening is a band aid fix to save the pension funds.
“If there was no intervention today, gilt yields could have gone up to 7-8 percent from 4.5 percent this morning, and in that situation around 90 percent of UK pension funds would have run out of collateral… They would have been wiped out,” Zerohedge.
Frankly, there is no easy fix; cut government spending and millions will starve to death, keep printing, and the currency becomes worthless.
Companies with sound fundamentals and strategic industries backed by the state might be the best place to hide during an era of high inflation, social upheaval, and geopolitical instability.