The Endgame Is Near: The Banking Crisis Of The 1980s May Return And There Is No Real Solution

As inflation surges past 7 percent in the United States and European energy prices are at multi-year highs, central banks may be in their endgame fighting an uncontrollable financial monster.

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Taking a quick look back at the situation in the 1980s learns us that the current situation may just well be quite similar. During the 1980s inflation reached double digit figures causing high inflation because of strong oil prices. These were partly caused by Soviet intervention in Afghanistan and the impact of the Iranian revolution, which frightened investors and disrupted energy supplies. In the same period gold hits record high at $850 per ounce, just nine years after the United States took the dollar off the gold standard.

In 1973 President Nixon had to devalue the dollar to gold, making an ounce of gold worth $42.22 dollar instead of the previous $35 dollar. This resulted in a selloff in dollars for gold by speculators fearing even more depreciation. Later in 1973 Nixon decoupled the dollar from gold completely, which made the price of bullion soar to $120 per ounce, ending the 100-year history of the gold standard. The following years inflation reached the double digits causing a huge crisis as wages were frozen. The overall value of the dollar has dropped 90 percent since the 1950s as more and more money was printed to overcome trade deficits and refinance long-term Treasuries used to finance wars and crises. This trend has continued following the financial crisis of 2008 when central banks used a new way of financing their debt by buying up Treasuries using digitally printed money. Following the 2020 pandemic purchasing programmes the Federal Reserve’s balance sheet is at an all-time high of over 8 trillion dollars.

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Figure 1 – Balance sheet Federal Reserve

With Russia standing at the borders of Ukraine as geopolitical tensions rise, oil prices creep higher and are ready to break to new highs surpassing the psychological level of $100 dollars a barrel. And as investments in oil and gas exploration projects are declining, while demand keeps on rising on red-hot economic recovery, this squeeze could last for a while. If the economy will see a similar pattern as in the 1970s and 1980s remains to be seen, however it is almost certain that developments will occur at much faster pace as markets are way more interconnected than forty years ago.

Cutting Inflation Or Financial Liquidity: Not An Easy Choice

As previously mentioned , prior the the pandemic the Federal Reserve already faced problems when they started with their quantitative tapering programmes slowly cutting the amount of assets on their balance sheet. This caused a financial crush in the interbank market that shocked the Federal Reserve. As fear started to mount, the Federal Reserve had to cut interest rates three times following their unsuccessful quantitative tapering programme. This time the Federal Reserve is not only expected to start quantitative tapering, but is facing inflationary pressure if they continue their current regime. Moreover, this time interest rates have to rise at a much faster pace to dampen inflation, but this could come at a cost, many SMEs are much more indebted due to the corona lockdowns. Facing higher interest rates to refinance their debt, this will hurt businesses hard. On top of that is the surge of non-viable zombie companies that have benefited and survived due to the ultra-low interest rate environment and now will face the harsh financial reality if interest rates indeed will be hiked as much as expected. As the Federal Reserve keeps postponing this decision inflation keeps to surge and consumers face the consequences, especially low income groups.

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This year will be a pivotal year for markets as volatility on markets picks up. Central banks are under increased pressure by civilians facing lower levels of purchasing power due to years of easy monetary policy. Their next step is vital to prevent a major financial crisis, but the current situation is not an easy one as picking the right balance between inflation and interest rates, e.g. purchasing power or employment. Interestingly, the European Central Bank is much more dovish than the Federal Reserve as they increasingly keep an eye on a third goal as well: the green energy transition. High carbon emission prices, along with higher oil, gas and coal prices is not necessarily a bad thing in the light of this vision. However, letting inflation rise to uncontrollable levels will come at a much higher cost for society. An underestimation of the danger of money depreciation could undermine the whole economy and hit back hard.

Disclaimer: The Golden Investor is not a fortune-teller, be sure to make the right decisions in accordance to your own financial situation, this is not investment advise or anything like that.

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