The Process Through Which the First Major Central Bank Goes Bust Has Begun
The comments above & below is an edited and abridged synopsis of an article by Phoenix Capital
After the financial crisis of 2008, central banks began cornering the sovereign bond market via zero or negative interest rates and QE programs. They wanted to reflate the financial system by pushing the risk-free rate to extraordinary lows; they wanted capital to flee cash and move into risk assets, thereby reflating asset bubbles.
The policies worked: The crisis was halted and the financial markets began reflating. However, central banks have set the stage for a crisis many times worse.
That crisis was triggered by large financial firms going bust as the assets they owned turned out to be worth less than the financial firms had been asserting. This induced a panic.
During the next crisis, this same development will unfold, only this time it will be central banks (not private banks) facing this issue.
Central banks are currently sitting on over $10 trillion in bonds that trade based on inflation. If inflation rises, these bonds will drop in value as their yields rise to accommodate the move in inflation.
When a central bank is sitting atop trillions of dollars in bonds, an inflationary spike inducing those bonds to drop could quickly wipe out $100 billion or more in capital.
The same central bank could simply print more money to prop up the bond markets, but doing so would increase inflation, which in turn would force bonds prices lower, inducing greater losses.
Policies like QE and ZIRP only work as long as the financial system maintains confidence in the currency a central bank is printing. When that currency begins to devalue because of inflation, the game is over.
This process has already started. The explosion of Bitcoin and other cryptocurrencies is just one way in which the system is losing confidence in primary currencies. The recent spike in bond yields is another. The time to prepare for this is now, before the carnage hits.