Goal Alert!

Not being a soccer fan myself, I am struck by the dedication that soccer fans put into the performance of their favorite teams. Without a doubt, there is great passion guiding fans to witness each game and shout each goal.

Technology has lived up to the passion of the fans and has provided high-definition streaming services for mobile phones, to watch the games at any time, with an additional service that catches my attention; the "Goal Alert", which is a message that arrives every time a goal occurs during a match of interest to the user, so that he can react quickly in case he is not connected to the broadcast of the match. The bad thing about the alarm is that when it arrives, the goal has already been scored, taking away a bit of the sparkle when seeing the repetition of the happy or sad event (depending on who's goal is it).

I was thinking how valuable it would be to have a service like "goal alert" for other important things in life. However, beyond having a calendar with important dates, the important things in life have a high random component, generally occurring when they are least expected or in ways that are not clearly defined. In addition, there will always be someone willing to tell us the latest news.

In the economy, as well as in soccer

The world economy is in trouble, you already knew that. During the month of March 2023, you should have heard about the problems of several important banks, such as the bankruptcy of Silicon Valley Bank, in the United States or the rescue of Credit Suisse bank, in Switzerland.

While bank bankruptcies in the United States and bank bailouts in Europe may not affect you directly, you probably have noticed the economic contraction and price inflation of the past year. The sum of these events are complex to evaluate and hard to forecast, however, I will explain why we should receive a "goal alert" in the economic field in a while.

A goal in the 90th minute

Soccer fans know what I mean; Part of the excitement of watching a game in the stadium or live on TV is the chance to see a last-minute goal (ideally from your team, of course). The whole match is passion and tension, until the final whistle seals the result. After this, all that remains is to celebrate or cry. This is part of the passion of soccer.

This phenomenon also occurs in finance. Every day investors follow the graphs of their investments on their screens as they rise or fall, until the market close seals their daily profits or losses. The sum of these transactions largely determines the daily value of goods as strategic as oil, natural gas, copper or wheat. These goods (in addition to all other tradable commodities) affect the economy in general and set the pulse of society. The excessive increase in the price of goods and services negatively affects the entire society, so containing inflation is the main mandate of central banks.

The most influential central bank in the world is the United States Federal Reserve (the Fed), as the issuer of the world's reserve currency, the dollar. All countries need to collect dollars to trade internationally. As I commented in another article (1), the dollar is at risk of losing its special status as a reserve currency, which would mean more economic turmoil.

The Fed has done everything possible so that the dollar continues marking the pace of the world economy, but, in my opinion, something has gone wrong. I explain:

After the 2008 Subprime crisis, marked by the fall of large investment banks such as Lehman Brothers, the Fed was faced with a possible recession and bankruptcy of the world financial system, starting with the United States, for which it devoted itself to paper walling the economy with money.

The Fed printed more than three trillion dollars (a trillion is a million million) and lowered interest rates to almost zero for about 10 years, something unprecedented in history. All the world's central banks followed suit by implementing the same measures with their respective currencies.

Then the pandemic came and the same measures were applied again, but on a larger scale.

That was the formula:

1. Printing money in quantum amounts to give liquidity to the market and allow the economy to revive.
2. Reduce interest rates to almost zero to encourage the issuance of more bank loans.

The expected result of this was increased velocity of money, plus...inflation.

In February 2022, the Russian invasion of Ukraine took place. That event scared the market by reducing access to a significant percentage of the oil, natural gas, fertilizers and cereals that those two countries exported. Inflation increased.

The Fed this time reacted by starting an aggressive rise in interest rates (2), stopping the printing of money.

This implied a new formula:

1. Stop printing money so that there is not so much liquidity in the market.
2. Increase interest rates to reduce the number of loans granted.

The expected result was to reduce the speed of money and encourage savings, which should translate into a slowdown in the economy and a reduction in price inflation.

But reality tells us that along with rising interest rates, yields on bonds (which is debt issued by the Fed) drop, of which banks like Silicon Valley Bank had many, leading it to insolvency and bankruptcy.

Fortunately, the Fed promised to cover the full principal of the deposits, so those who had their accounts at Silicon Valley Bank (mostly technology companies and start-ups) did not lose their funds.

Unfortunately that bailout was made with newly printed money, which causes inflation, which is exactly what the Fed was fighting against in the first place by raising rates.

A player with two left feet

The Fed is moving the wrong pieces this time. To continue with the example of soccer, although a team requires a goalkeeper, defenders, central defenders and attackers, a different combination can break the game schemes and become a fiasco.

Today the Fed is achieving five undesirable things:

1. Slowdown in the speed of money, with an economy that is not growing.
2. Bailouts of banks with newly printed money, which pushes inflation up.
3. Greater debt, since rate hikes also affect the interest on the gigantic US and world debt.
4. Contagion, because now the economies with problems are not Italy or Greece, but Germany and Switzerland, supposedly the most solvent countries in Europe.
5. Greater risk, since there are 50 other banks in the same situation that Silicon Valley Bank was in before it went bankrupt.

If we add to the global economic situation the geopolitical factor, with the threats from the BRICS countries; Russia, China, Brazil, India and South Africa to the hegemony of the US dollar, we have a primal broth that can cause big problems.

And there is the State Department of the United States that has not done the dollar a great favor either. Once it was decided to sanction Russia for the invasion of Ukraine, apart from freezing all of Russia's financial assets, the country was excluded from the SWIFT system, which allows the flow of dollars when making international transactions.

My gut tells me that this time the Fed was wrong to raise rates so quickly and is going to have to change course. At the same time, I think that the US government went too far when turning the dollar into a geopolitical weapon (well, thats's not news).

The damage is already done. We are going to have a goal alarm, but this time the score will be into it's team's own goal. Already the small pieces falling are pushing the larger ones, in the United States and across the ocean.

This self goal inflicted by the Fed may generate such a panic that it stampedes out of the dollar (which is slowly happening already). Given this, the Fed will do what it does best; printing dollars in fast and furious mode, pushing inflation to levels beyond the clouds.

Inflating the ball

Just as in soccer no one plays without the ball, between countries no one trades without the US dollar. The printed dollar base is 5.3 trillion (3) and continues to rise. The base of assets denominated in dollars and financial derivatives exceeds one quadrillion dollars (that is a number 1 followed by 15 zeros).

The prospect of dollar-denominated hyperinflation is frightening, but not impossible. Both in Weimar Germany in the 1920s (4) and in Zimbabwe in the 1990s (5), hyperinflation occurred due to excessive money printing. In both cases the consequences were disastrous for people.

The recent actions of the Fed by rescuing troubled banks indicates that printing dollars is the main weapon of the Fed and therefore of all the central banks of the world. If a tipping point were to occur, be it an economic trigger or a geopolitical black swan, the most likely result is that first the economy will come to a standstill, and then, in response, we will be flooded with printed and digital money, leading to much higher prices in the entire basket of products.

If you can see the scenario ahead, then get ready. If you can't see how slowly until now, but faster and faster our world is changing, then there will be no shortage of some good soccer match on which you can focus all of your attention.

Blessings,

Luis Leighton

1) https://saludfinancierachile.blogspot.com/2023/01/the-strange-case-of-economic-fall.html

2) https://fred.stlouisfed.org/series/FEDFUNDS

3) https://fred.stlouisfed.org/series/BOGMBASE

4) https://en.wikipedia.org/wiki/Hyperinflation_in_the_Weimar_Republic

5) https://saludfinancierachile.blogspot.com/2010/11/preparese-para-combatir-para-la.html