Printer is Coming (in the UK)
This week, the Bank of England had to fire up its money printer before it even started shrinking its balance sheet. Who is next?
It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.
Mark Twain
In an unprecedented move, the Bank of England (BoE) had to bail out British pension funds that got caught on the wrong side of a poorly designed leveraged trade. To calm markets, the BoE said it would buy up to £65bn of government bonds (I won’t put a $ equivalent amount because the £ trades like a crypto these days, but it’s a lot of money!) with money it will create out of thin air (yes, it’s what central banks can do). Click on the thread below for a full explanation of what went wrong.
If you prefer a TikTok-like explanation, here it is with a one-minute video:
Long story short, because yields have been rising this year, the value of bonds has been going down… a lot! Look at the price of the UK government bond below maturing in 2061: From 97 at the beginning of the year down to 24 earlier this week. A 75 percent drop in less than one year for an asset that is supposed to be “risk free” if you open any finance textbook. And it’s not even accounting for the depreciation of the British Pound against the US Dollar. Even the price chart of Bitcoin looks great next to it!
British pensions funds were stuffed with this type of assets. But where it really went wrong was that they had used leverage to buy even more bonds to increase their return. They played. They lost. They got bailed out. Sounds familiar? It’s because it’s the 2008 playbook all over again.
Confused by the mechanics of this bailout? Good. You still have some common sense.
In the short term, the BoE has restored calm in the market. But the current situation is untenable. The UK Government and the BoE are pulling in two opposite directions. One of them will have to cave. Round 1 went to the government. Mohamed El-Erian explains in the interview below why what the BoE did is just a temporary fix.
Ironically, the BoE was supposed to start talking about shrinking its balance sheet this week. Instead, they started printing money again! You can’t make this up. Quantitative Tightening (QT) is over before it even started (see my previous newsletter here for an explanation of how QT works).
Finally, the situation in the UK was so bad that the International Monetary Fund (IMF) issued a warning, like it usually does with developing countries. The last time the UK had to be bailed out by the IMF was in 1976.
One person got the situation completely wrong: Paul Krugman. After getting inflation wrong 18 months ago (he said inflation wouldn’t be an issue), Bitcoin wrong ten years ago (he said it had no future when it was worth $8 a coin), he decided to add another wrong prediction to his record: The UK would not experience a currency crisis. Four days after the tweet below, the BoE had to bail out the UK financial system to avoid its total collapse.
The template that all central banks will end up using to explain why the couldn’t get inflation under control will probably look a lot like this:
While their currency was imploding, where did British Pound holders flock to? If only there was a currency with a fixed supply and an immutable monetary policy…
The Carnage Continues in Financial Markets
Remember 2008 and how it was the end of the world for financial markets. It was actually just a blip compared to what is unfolding in 2022.
Markets keep going down for the same reason they have been going down for months: The US Federal Reserve is raising rates and markets are expecting a nasty recession.
Central banks can’t do a full U-turn yet because inflation is still extremely high. It is above 10 percent in the eurozone, with some countries experiencing even higher inflation (17 percent in the Netherlands).
Legendary investor Stan Druckenmiller, who famously broke the Bank of England in 1992, is not optimistic about where the world is heading.
Geopolitics: The Plot Thickens
Nobody knows who blew up the Nord Stream 1 & 2 pipelines, but it’s major geopolitical event.
Let’s look at who stands to benefit or lose from these two critical gas pipelines being (permanently) damaged:
Losers
Russia: Lost the ability to negotiate with Europeans to turn the gas tap back on.
Europe: Lost a piece of infrastructure that could have provided up to 50 percent of its gas supply,
Winners
Ukraine: The gas pipelines going through Ukraine to Europe are more valuable than they have ever been. They are the only game in town now.
USA: Europe will be dependent for the decade to come on Liquefied Natural Gas (LNG) shipments from the US.
Vladimir Putin: Even if Putin is ousted, whoever takes over from him won’t be able to turn the gas tap back on. One less reason to overthrow him.
The situation is becoming increasingly inextricable…
In Europe, Italy elected Georgia Meloni as prime minister. Watch her speech attacking French President Macron below. Fun times ahead in Europe…