inflation, dept, banknotes

Burn the banknotes to keep warm: Can central bankers issue HGV permits? Is it possible to launch container ships built of paper money? Could we use banknotes instead of gas to stay warm? Will the helicopters of the Federal Reserve cause our windmills to turn?

When retailers are restricting purchases, how much toilet paper can you buy with your stimulus cheques? How many Bank of England employees may be reassigned to refilling shelves at Tesco Waitrose?

To believe that tighter monetary policy can cure our current bout of inflation is equivalent to believing that sinking a ship will bring it closer to land. You've absolutely missed the mark.

Inflation, you see, is driven by economic upheavals. Even outside of Brexit Britain, there are bottlenecks everywhere.

Omicron is enforcing ghost lockdowns, and spending in some cities has reached lockdown lows.

Governments impose labour stoppages by isolating citizens. Other countries continue to impose physical lockdowns. Australia, as usual, is not to be outdone, and has imposed “lockouts” as well.

The big resigning continues, with the unvaccinated supplanting the economically disillusioned and early retirees. And sometimes it's a firing rather than a resignation.

The list could go on and on. And the ramifications of all of this are on display as well.

We've ran out of new commodity prices to spike and crash, so we're back to the likes of lumber, which is once again on the rise.

Similarly, stores are reintroducing toilet paper rationing. Even without lockdowns, several Australian city centres resemble ghost towns.

Almost a month after US President Joe Biden declared victory over the supply chain issue, ports are still clogged with ships, containers, lineups, and trucks.

At the end of last year, food prices were close to a record high.

Retail energy prices in Europe are skyrocketing as businesses tyre of going bankrupt and instead pass on expenses.

The list of factors for rising inflation goes on and on. But the point is that raising interest rates and reducing quantitative easing (QE) does not address the underlying issues, nor do they address the repercussions of those issues.

Tighter monetary policy, on the other hand, may exacerbate all of them.

Debt is used to fund trade. Companies borrow money to purchase the items they move. Making that debt more expensive means that fewer items are moved, price hikes are passed on, or company earnings suffer significantly.

Time is money in the realm of trade and commerce. Interest rates represent the cost of time. As a result, when interest rates rise, delays become more expensive.

Similarly, projects to alleviate bottlenecks are debt-financed.


Perhaps most importantly, the chance of corporations going bankrupt becomes more likely as their debt gets more expensive. As one Australian Financial Review pundit put it, “Be afraid: the zombie economy can't last.”

No, the financial media hasn't developed a sense of humour. The phrase “zombie company” is a technical word. It is a corporation that is unable to fulfil its own debt payments through profits. In other words, it needs to borrow more to pay off past debts. Rising lending rates make this more difficult, pushing more businesses over the brink.

Would you lend to a corporation that is unable to pay its debts at higher interest rates if you believe greater interest rates are on the way? What happens if individuals quit lending to that company?

As a result, tightening monetary policy now may increase inflation by adding financial bottlenecks to supply limitations.

Don't get me wrong here. Given inflation, unemployment, GDP, and debt, interest rates should be closer to 10% than 0%. However, this would precipitate a massive debt crisis. In fact, we might already be in one… sort of.

My colleague John Butler, who first warned you about inflation days before it began last year, has been pointing out a corporate debt bloom that has taken up over at Southbank Live. Find out why and what it means for investors in this article.

But first, let's go through the basics. Tighter monetary policy will not solve the problem of inflation. But we do require it. But if we get it, it will almost certainly explode a debt bubble…

This leads to what appears to be an impossible conclusion. Since the 1980s, at least, there has been one outside the Overton Window. The concept of purposefully popping a bubble.

The first rule of a bubble is that you do not talk about it.

Bubbles, you see, nearly invariably explode. Nobody expects them to. They do, however, eventually.

This poses a fascinating topic. What should we do if the monetary policy should not be this lax, yet strengthening it would cause a crash?

Should the bubble be broken immediately, or should it be allowed to continue for as long as possible?

The recent bout of inflation has forced central bankers to make this decision.

Of course, the central bank's duty is meant to be to take away the punchbowl when the celebration gets out of hand. But they're too busy these days spiking the punch with unconventional monetary policy.

The other responsibility of central banks is to deal with financial crises. But what if their own monetary policy is to blame for the financial crisis? What happens if the crash is caused by tighter monetary policy aimed at containing inflation?

The point is that central banks have a monopoly. They must make a choice amongst their several mandates. For the first time in decades, inflation is compelling them to do so.

Perhaps more important than all of this is the possibility that inflation will continue to climb to the point where any attempt to control it will appear inadequate.

You see, once inflation has taken hold of an economy, only the most dramatic measures will be able to stop it.

That is why, even if what we have seen thus far may not be actual inflation – price spikes caused by supply chain disruptions are not devaluation of money – true inflation may be on the way.

Tomorrow, we'll look at how governments' answers may be just as effective as central banks' (in making inflation worse).

Nick Hubble
Editor, Fortune & Freedom

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