Central Banks play Whac-A-Mole

The topic of national debt is prevalent in the financial media however the implications are not often presented.

National debt, like corporate and personal debt requires lenders to have confidence in the borrower to be able to service and repay the debt.

While that is obvious, at a national level, that confidence is tied to the ability of the nation to maintain the value of their currency. Even for the US that can print the reserve currency and so can’t default, currency devaluation undermines confidence. View the recent devaluation with that lens!

A decline of confidence can manifest itself in several ways:

• Increase in interest rates – effectively price increase in risk.
• Inflation – devaluation of the national currency
• Liquidity crisis – no trust nor funds to lend a la 2008 GFC.

Central bank (CB) action to address any one issue makes the others worse.

If inflation strikes, the CB raises interest rates. Interest rates add to cost of production (thereby increasing prices) and reduce some expenditure and investment (reducing demand). Until defaults and bankruptcies start to really appear killing enterprises and employment, inflation will worsen. When the defaults become commonplace then liquidity will be challenged.

If interest rates rise through market action (i.e. lower confidence) then liquidity is challenged. Any liquidity issues then CB action will be to push more QE which inevitably lead to inflation.

So high debt leads to low confidence which brings in the Central Banks Whac-A-Mole game dealing with inflation, interest rates and liquidity. As every CB action is late/delayed, overshoot is guaranteed. CBs will take increasing action until the economy is destroyed or fully controlled.