Mario Draghi got a straight A grade from Janet Yellen as quoted in a Wall Street Journal interview (Source: Wall Street Journal, February 12, 2021): “Whatever it takes will go down in the annals of central banking history as the most important interventions ever. It’s hard to imagine where we would be without it.”
Indeed, an un-elected technocrat with the power of the printing press behind him has now made history as the appointed, unelected Prime Minister of Italy. Yellen, making her own history, is the first female Treasury Secretary of the United States (which is always an un-elected position). Central banks and central bankers have always been political institutions with subterranean political ambitions, and now they have discovered that one shortcut to the helm of the country is to give elected officials who have the power to appoint them what they want – buckets of free money under the now respectable practice of unlimited money printing. They have the world’s economies so dependent on their power to print money that they will, in all likelihood, begin to control governments and their policies, without having to be voted in. Monetary policy has conclusively overflowed into fiscal and political philosophy, and its ramifications for asset prices and portfolios are immense. Move aside Wall Street – retired central bankers now aim for the Palazzo Chigi or more. There is also a competition ready to erupt between Bitcoin, the “elected” digital currency of its network of users, and “appointed” digital currency, known as CDBC (Central Bank Digital Currency), which will likely be quite consequential for investors.
To catch up readers on the context: Just a few years ago it seemed like Italy was going to have to default, and as the third largest economy in Europe, this event would result in an inevitable implosion of the European Union. In a now famous gunslinger speech, Draghi, then the President of the European Central Bank (ECB), told investors around the world that the ECB would not let this happen, and reversed the course of history that his descendants at the ECB in particular and the rest of the world of central banking have equated with the second coming of a “monetary messiah”.
In short, Draghi convinced the world that the central bank possessed the will and the ability to do as it pleases, despite the objections of the frugal German members of the ECB – both in terms of money printing, buying up assets, and re-distributing this wealth. The acts of the US Federal Reserve in 2020 (Powell’s “crossing of red lines”), and of others is a rerun of the Draghi resolve, and convinced a cadre of central bankers to the point that now money printing, credit extension, and buying of assets is considered not only normal, but expected. New, Herculean, perpetual motion machines with uncontested powers have been found, and to cite Draghi once more, “believe me”, they are being used.
The ECB has bought up multiples of the net supply of both sovereign and corporate bonds in Europe. Functionally bankrupt countries can issue bonds at negative yields, and even corporations who possess the option to default can sell their debt to the ECB at prices that mean a certain loss for the ECB if held to maturity. Banks in Europe can borrow at more negative yields than the loss that they incur from placing reserves at a negative yield with the ECB, miraculously turning two negatives into a positive. But the bond market-driven re-distribution in Europe is probably done, with nary a peep from the old bond vigilantes. Central bank digital currencies will likely be the next lever to extend the reach of the central bank monopoly into every citizen’s pocket. Watch out Bitcoin!
This is little more than monetary policy surreptitiously replacing fiscal policy along the way to re-shaping politics. In a world swimming in liquidity, negative yields are a way to transfer wealth from the haves (savers) to have nots (borrowers). Countries like Italy, who are not able to get their fiscal and political matters straight under the best of circumstances were (and are) being rewarded for their mess by the sugar-daddy ECB policy engineered by their own Draghi.
If Europe is a family of countries that have committed to supporting each other for the foreseeable future, this policy makes eminent sense. In the United States, we take Federal tax revenue and distribute it to needy states, or states run by politicians who know how to bring home the pork. For a family to continue to exist in harmony, the responsible sibling has to be willing and able to support the wayward one. At some point Northern European savers will revolt against this profligacy. Even the most patient member of the family has a limit when it comes to re-directing the fruits of labor to waste forever. Tensions are certainly building. But for now, the seemingly free generation of wealth has few opponents.
For investors, the signs are as clear as can be. Money printing, while it lasts, will likely be used to solve all problems. Rising asset prices may keep asset owners compliant for now, and redistribution of wealth may keep the needy (and the noisy) happy. So far this has been achieved primarily by the purchase of bonds by central banks – more bonds than are being issued. Many believe low interest rates and jawboning will ensure an accelerating race to the bottom for all fiat currencies. Whoever can devalue fastest will win in the short run, with the dollar likely to win out in the race to the bottom. Other than forced buyers, I believe that bond owners may find that in the long run, they have lost the most and been cooked alive. And if the political climate changes, bond market watch out below! How much easier will it become to exercise monetary policy as an arm of fiscal policy if frictions were removed by making the currency of each land purely digital.
Seeing the inevitability of this outcome, investors will get real. Those with access to real assets, confiscation, and repression proof assets such as gold, silver, rare earth metals, and even bitcoin will seek to accumulate them before governments, threatened by the risk of an en mass exodus from fiat currencies, perhaps make them illegal, or replace them with their own digital currencies, like India is considering. In the US, the 1934 Gold Reserve Act, with the long title “An Act to protect the currency system of the United States, to provide for the better use of the monetary gold stock of the United States, and for other purposes”, sets precedent for confiscation of anything that challenges the central banks’ monopoly on currency. Bans for private crypto could be veiled behind rhetoric that crypto-currencies are illegal because they facilitate illegal activity. Which will give central banks the perfect excuse to find the next method to tax its citizenry – central bank digital currencies.
When this happens, governments hope to be able to dip into the digital wallet and take what they want, when they want. In the evolving hegemony of un-elected officials pushing the boundaries of economics, money and politics, for smart investors this is a time to build portfolio defense against more aggressive interventions and legalized confiscation. And yes, when it comes to the bond market, it seems that the ECBs interventions have served its purpose in redistributing wealth, even though the cost has been enormous for savers. From here on, private holders of bonds are on their own. My own preference is to keep duration very short, buy real stuff that will soon be fashionable again as fiat currency becomes more funny than it already is, and use non-central bank digital currencies while they are still legal stores of value – but those days could be numbered and become relics of history.