Central Banks around the world will continue to increase interest rates as part of their policies to end the inflationary consequences of their own expansionary monetary policies in recent years.

These policies feed into rate increases for all forms of debt and a restriction on new lending. As a consequence, stock markets are crashing, government and corporate bond prices are falling, and new investment is collapsing.

A generalised economic recession across the capitalist world is an inevitability. Most Central Banks are officially predicting just that and simply promising to try and soften the blow.

But to beat inflation the Central Banks also have to start withdrawing the trillions of dollars they have created since the 2008 recession. The US Fed’s balance sheet, for example, has increased from $1 trillion to $9 trillion since then.

Asked at a press conference on May 1 about the effect that balance sheet reduction might have on monetary policy, Powell replied: “In terms of the effect… I would just stress how uncertain the effect is of shrinking the balance sheet. You know, we run these models and everyone does in this field and make estimates… And you know, these are very uncertain. I cannot really be any clearer.… We don’t really know.”

This is an incredible admission from the supposed superstars of capitalist economic thinking. Central Banks worldwide have been invested with a mystique of being virtually infallible masters of the universe.

What we do know is that each previous time the US Fed has tried to reverse course on money printing the money markets essentially froze and no one was willing to lend to anyone else.

I explained this in more detail in a December 2020 blog headed “Printing money to save the power and wealth of the 1% is just stupid”. To prevent a broader collapse money printing was resumed.

However, we now have the need for the system to crush inflation which means that this time the Central Banks will have to sit by and watch as a broader collapse unfolds. This will begin at the weakest links in the system. All debtors – personal, corporate, and countries are at risk as interest rates rise relentlessly.

Simply the promise to increase rates from below zero to above zero by the European Central Bank has created a crisis in Italian government debt which immediately began to be targetted by the “Bond Vultures”.

I’ll quote a bit from the payrolled article from the Financial Times reprinted in the NZ Herald on June 15 headed Surging borrowing costs take Italy ‘close to the danger zone’:

Investors are questioning how far Italy’s borrowing costs can rise before they rip a hole through the heavily-indebted country’s economy, as a sell-off intensifies across eurozone bond markets.

Yields have shot higher in the bloc since the European Central Bank last week signalled an end to the stimulus measures it ramped up at the onset of the coronavirus pandemic. ECB president Christine Lagarde confirmed plans to withdraw a large-scale bond-buying programme and to initiate interest rate rises next month to tackle record levels of inflation.

In turn, Italy has found itself in the market’s crosshairs, because of its need to refinance a borrowing load of around 150 per cent of gross domestic product. Investors are dusting off calculations from the eurozone debt crisis a decade ago as they try to understand when the rise in yields could start to imperil finances for the Italian government as well as for companies and households.

“You can tell things are getting bad because people are starting to publish papers on Italian solvency again,” said Mike Riddell, a bond fund manager at Allianz Global Investors. “The market isn’t panicking yet, but all this focus on Italy is starting to feel a little like 2011,” he added. Back then, worries over Italian debt sustainability pushed Italy’s 10-year yield to a record high of more than 7 per cent. It touched an eight-year high of 4.06 per cent on Tuesday.

The spread between Italian and German 10-year yields peaked at 5 percentage points at the height of the debt crisis a decade ago. Andrew Kenningham, an economist at Capital Economics, said he did not think the ECB would let it get that high, predicting it would intervene once it reached 3.5 percentage points.

The recently extended average maturity of Italy’s outstanding debt, at over seven years, means the recent rise in yields will feed through only gradually to the country’s average interest cost, according to analysis by Goldman Sachs. However, seven-year borrowing rates have already blown past 2.75 per cent, the maximum level at which Rome’s debt load would stabilise, according to the bank. Italy’s seven-year debt traded at a yield of 3.79 per cent on Tuesday.

With prime minister Mario Draghi’s market-friendly government facing elections next year, any political instability “could well end up being a catalyst for renewed concerns about debt sustainability”, Goldman Sachs said.

Investors are also watching the gap between Italian and German borrowing costs — the so-called spread — which has widened to 2.4 percentage points, from around 2 percentage points before last week’s ECB meeting.

Failure to adopt policies to break inflation will simply lead to additional negative conseuences as currencies decline in value. The Japanese yen has delcined 15% against the dollar because they have resisited the end of easy money policies.

The central bank has pledged to fight so-called “fragmentation” of the eurozone financial system, but investors were unnerved by the lack of detail last Thursday on a new “instrument” to keep a lid on spreads.

Fund managers like Riddell who are betting against Italian bonds believe Italy’s spread has not yet reached levels that would prompt the ECB to intervene in markets. “The ECB had the opportunity to be more dovish and they turned it down,” said Riddell. “It’s almost an invitation to the market to cause more stress.”

Yields surged higher still on Tuesday after Dutch central bank president Klaas Knot told Le Monde that the ECB would not be limited to a half-point rate rise in September — opening the door to a 0.75 percentage point move.

“We are getting close to the danger zone,” said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, adding that the ease of trading Italian debt has deteriorated somewhat.

“I understand why the ECB is reluctant to move,” said Ducrozet. “But . . . if bond yields passed the pain threshold, the re-pricing might become self-fulfilling and the ECB would be unable to stop it unless they step in massively.”

As well as the longer maturity profile on its national debt, Rome is also benefiting from more than €210 billion ($351.7b) of grants and cheap loans from the EU’s Next Generation recovery fund.

But the ECB worries about a disproportionate rise in Italian borrowing costs, not only because of government debt sustainability, but also because they act as a floor for the overall financing costs for companies and households. In the first four months of this year, average Italian mortgage rates rose from 1.4 per cent to 1.83 per cent, a three-year high, according to the ECB.

The Italian central bank said the amount of medium- and long-term debt the country has to refinance will increase from €222b this year to €254b next year, which combined with drastically lower purchases by the ECB is likely to increase upward pressure on yields.

Rome may have to rely more heavily on Italian financial institutions to buy more of its debt, which could reignite concern about the banks’ vast domestic sovereign debt exposure.

At the end of April, Italian banks held over €423b of domestic government debt securities and €262b of loans to their government, only slightly below their peak levels in 2015 following the eurozone debt crisis, according to ECB data.

If this increases further — and foreign investors were already reducing their exposure to Italian sovereign bonds last year — it could reignite fears about a vicious circle between private sector lenders and governments weakening each other, and ultimately threatening the existence of the single currency zone.

“Eurozone banks are in better shape in terms of capitalisation and stock of non-performing assets,” said Lorenzo Codogno, a former chief economist at the Italian treasury. “Yet, they still have a sizeable position in domestic government bonds in many countries. The sovereign-banks doom loop can still be triggered.”

Italy is trapped in the Eurozone without its own currency so can’t adopt monetary policies independently. The European Central Bank will keep raising rates and reducing its own balance sheet (which includes Italian government bonds) to crush inflation. It can’t protect the Italian Bond market at the same time. A crisis is inevitable for Italy and other more indebted nations.

Working people need our own solutions to the capitalist crisis that is coming. Private ownership of wealth is the ultimate source of the problem. The owners of wealth (financial, industrial and land) are only interested in maximising their profits and wealth at the expense of working people and the planet. Democratic ownership and control of wealth in all its forms is the only path out of the crisis we will be facing. We can then use that control to solve the world’s pressing problems, from climate change, the environment, housing, employment, welfare and education in a manner that meets the needs of the vast majority of humanity not the greed of the 1%.