The halls of power are filled with the mutterings of a new theory. One which will change the world.
Just like those that came before it…
The new ideology is replacing Modern Monetary Theory. MMT, in turn, replaced Austerity. The Great Moderation came before that.
Before I tell you about this new theory, let me emphasise…
The importance of such beliefs cannot be overstated…because so often they break down just as they reach critical mass.
For example, not long after MMT became popular with governments, we got the inflation which MMT critics warned about.
Between 2003 and 2007, the Great Moderation belief was ascendant. It was the idea that centrals banks could engineer low inflation, full employment and end the boom bust economy.
We got a massive financial crisis in 2008.
Between 2010 and 2019, austerity trashed the economies of Southern Europe.
In each case, the fashionable ideological beliefs of the moment determined what happened next… before being abandoned as flawed.
Such an ideological reversal has just happened again.
A new theory is spreading amongst the elites who control the levers of economic power. It will be behind the next series of shocking policy mistakes.
If you understand the theory, you can predict what they will do.
The new theory you’ll soon be hearing about daily is called… ‘Fiscal Dominance’
In a way, it’s a very simple idea.
Government debt across Europe and in the US is too high to raise interest rates. Any more hikes would send the relevant governments bust.
That means central banks are now powerless. Monetary policy is moot.
Fiscal policy (government spending and taxation) now holds the cards when it comes to economic policy.
If the government spends too much and taxes too little, you get inflation.
If it spends too little and taxes too much, you get a recession.
Central banks have no choice but to fund the government and keep interest rates low to avoid a sovereign debt crisis.
This makes inflation a fiscal phenomenon.
The implication? Politicians now run the show, not central bankers.
That’s a concerning idea.
Politicians can’t run an economy and certainly can’t be trusted to manage inflation. That’s why we came up with central bank independence in the first place.
That said….
Fiscal dominance is really nothing more than a theory.
But I think it’s a load of hokum. In fact, I believe precisely the opposite is the case.
Let me prove it to you, before I explain the implications…
The Fiscal Dominatrix
At the end of 2022, the new UK Prime Minister published the first half of her budget. It unveiled a load of tax cuts. The associated spending cuts would come later.
But the market ignored that second part. It reacted as though the UK government’s deficit was about to go through the roof.
The unusually large spike in bond yields caused a domino effect in the bond market. Pension funds began panic selling bonds.
This got out of control quickly. At one point, a good chunk of the UK pension fund industry was about to go bust.
Within months, the Prime Minister was fired for her bungled budget and the chaos it caused.
At the time, I wondered why the Bank of England didn’t intervene in the bond market faster. Why didn’t they buy bonds to stabilise prices? It’s their job, after all.
Lately, the Former Prime Minister Liz Truss is claiming something sinister. She argues that the whole thing was a deliberate ploy to get her out of government. The Bank of England conspired to undermine her.
This may sound shocking. But consider that it’s not particularly rare for bond markets to help boot out governments. Or to interfere in the political process.
During the European Sovereign Debt Crisis, the Greek government was so afraid of spiking bond yields that it ignored a referendum result!
Despite Greeks voting ‘No,’ their government accepted the European Central Bank backed austerity program.
The Greeks in power “resigned” their Finance Minister Yanis Varoufakis for good measure…because he didn’t want to go along with it.
Similar shenanigans happened in 2018 with the Italian government. Each time the government tried to exert its democratic mandate; bond yields would go up. Each time the government gave in to central bankers’ demands; bond yields would go back down.
Behind the scenes, the ECB was buying and selling government bonds at the time.
The question we don’t know is whether they were behind the marginal moves. And were they controlling the bond market to pressure the Italian and other EU governments?
Even US President Bill Clinton was forced to reverse his whopping budget deficit when the bond market plunged under his reign too. His reputation as a fiscal conservative came from the bond market whipping him into place.
There are countless other examples. Each time, governments attempt to implement the economic policy they were elected to. But then players in the bond market push up their borrowing costs. And so politicians abandon their plans.
My point being is that Fiscal Dominance
has it precisely backwards.
Governments are not in control at all.
They are so reliant on central banks to finance them in the bond market that central banks are the ones that remain in control.
If central bankers don’t like a tax cut, they can just allow the bond market to intimidate a prime minister.
If central bankers want austerity, they can allow the bond market to force the government to impose it.
If central bankers don’t want a country to leave the EU or eurozone, they can allow bond markets to remind the government what that would mean for their borrowing costs.
The central bankers are in complete control of the world’s most powerful politicians. They are pulling the purse strings like puppeteers.
If you want to predict what happens next in the world, don’t ask what politicians have planned. Ask what central bankers want them to do.
I’m keeping that for my subscribers’ eyes only, over at Strategic Intelligence Australia. But I will reveal my conclusion here…
You can expect a series of inflationary “surprises” as central banks attempt to pay off the government debt by inflating it away. Instead of repaying the money owed, the money will become worth less over time.
That’s what inflationary “surprises” achieve. But they have to come as a surprise to have the intended effect. Otherwise bond investors will just demand higher interest rates, offsetting the effect.
In such an environment, investors should own hard assets and energy. That’s because their globally traded prices can just rise with inflation.
Find out more here.
Until next time,
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Nick Hubble,
Editor, Strategic Intelligence Australia
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