Do people understand what happens when the Fed “raises interest rates” to “combat inflation”? No. But it’s simple. They give the biggest banks more free money in the hopes that it will bribe them from giving you money – because you fuel inflation after all, not them.
The primary vehicle for raising rates is raising the interest rate that the primary US banks receive for parking their reserves (think bankers’ cash) at the Federal Reserve. In other words, the Fed gives them more free money for simply idly parking their cash and doing nothing. The aim of this is that they’ll turn around and say, no peasant, I will not give you that loan – why would I give it to you when I can give it to the Fed which offers me more, and is guaranteed to be able to print my return? You might lose your job – I won’t risk it on you. I’ll keep it within the bankers club instead. “Rules for thee and not for me”. You are the peasant, they are the lords of the manor. Free market capitalism died a long time ago if you did not know.
Of course, there is another reality that has been a bit more unsettling for banks. Central Banks are also buying fewer govt. debt and mortgage backed “assets” with their funny money to combat inflation. They’ve even promised to sell them back onto the market (although little of that has actually happened yet). When they don’t buy with their unlimited funds, it reduces demand. And when they sell, it increases supply. Both these actions bring the current market value of assets down. This in turn shrinks the market value of assets on the balance sheet of many financial institutions. The most telling of which appears to have lately been the entire UK pension fund system. The Bank of England had to restart their asset purchase program recently, which they had promised to pause, because otherwise a slew of financial institutions would be insolvent today, potentially sparking another global financial crisis.
Many banks will go under throughout the world if this policy of tightening is maintained. It won’t be. It will be maintained long enough to cause massive pain, and perhaps slow inflation, but not enough to end this inflationary era we have moved into. When faced with mass bankruptcy or further inflation, governments & central planners will choose inflation. The only question is how much pain they can bring upon business owners and the general populace via deflation, before they are “forced” to quietly bail out financial institutions again, and return to causing pain to the general public via inflation. The biggest institutions needing a bailout are of course governments themselves – with astronomical amounts of debt, the govt cannot afford to pay high interest on bonds for long. Perhaps after pivoting back to inflationary policy they’ll use price controls to “lessen” the impact on the peasants. We’ll see how that turns out.
In a normal world, central banks selling assets would actually be good for private banks – because as demand for bonds & assets slackens from less funny money being injected, the market value of these assets goes down but the interest paid to own them rises. Interest rates have an inverse relationship to market value with bonds: lower value equals higher interest. This should be good right? You could buy more assets AND get paid more interest for owning them? Right? But we do not live in a normal world. We live in an economic dystopia – people just don’t know it yet. In this dystopia, which has been brewing for 100 years since the inception of central banking, but which came into maturity after 2008 – almost all banks and all financial institutions are over leveraged and have evolved to live ONLY in a low interest rate environment, where the market value of assets like bonds, stocks, and real estate only goes up, and interest rates only go down.
There will be a lot of pain to come throughout the world, and then eventually in the US – perhaps last of all. But ultimately govts and banks will choose to preserve their power to print money and maintain their dominance. They will not willingly declare themselves bankrupt and hand themselves over to people and other govts who are under leveraged and wisely protected their money. The people will be put in their place – to suffer the brunt of the pain from both deflation and inflation, and the economic regime will march on further and further away from freedom & free markets. Unless something changes.
Jonathan thinks and writes about the financial system and how it impacts the lives of ordinary people. While recognizing that we have little to no control over the powerful forces that control each and every one of us, he at least explains it so we can understand what is happening, and why…