By Chris Fry
During the height of the Covid pandemic, the Federal Reserve, the central bank of U.S. finance capital, did two things to sustain giant corporations during that period when most had to shut down most if not all their operations: 1) It lowered the interest rates offered to companies to near zero, making huge amounts of cash available to Wall Street; and 2) It bought a huge amount of government and corporate bonds, which put a tremendous amount of cash into the financial system and into the coffers of the banks and big business.
Of course, for the laid-off workers and oppressed, they received only some temporary government assistance. Even the tax breaks for children, which took millions out of poverty, dried up at the end of 2021, putting them right back into it. Rental and mortgage assistance disappeared as well.
Federal Reserve’s Chairman Jerome Powell’s current “inflation fighting” strategy includes not only raising the central bank’s interest rates, but also selling the government and corporate bonds that it bought during the Covid pandemic. Powell is falsely blaming the high inflation rate on the temporary relief measures that the working class received during the pandemic, which have in fact all expired. The pandemic actually increased the monopoly power of the biggest companies in each sector of the economy (energy, food, etc.) to set higher prices without the restraint of competition.
In fact, the money that was raised for the banks and corporations during the pandemic by their getting “free money” from the Fed was used by investment banks to finance derivative speculation, amplifying the huge profits that they were and are raking in. So all that cash generated the unprecedented inflation rate that the workers and oppressed face today at the gas pump and grocery store.
As Big Business reopened their operations, they confronted a worker shortage, putting our class in a stronger bargaining position to demand higher wages and benefits. Unions have reached a level of popularity not seen for many decades, and organizing drives and strikes have erupted across the country. Small wage gains were won, but still lag far behind the inflation rate.
To counter this, the Fed is deliberately reducing the money available for businesses to borrow to sustain and expand their operations, which will inevitably lead to layoffs of millions of workers. This is designed to intimidate and impoverish the increasingly restless working class.
Also, by raising interest rates and selling the bonds that it had bought during the pandemic, the Fed is taking huge amounts of money out of the system. This has the effect of raising the exchange value of the U.S. dollar, its relative value versus the rest of the world’s currencies. Since the dollar is used by governments and international corporations to pay their debts, this is having an explosive effect on the world economy, including Europe, whose capitalist ruling classes have tagged along with the U.S. ‘s proxy war in Ukraine.
A New York Times September 30 article describes the day that the entire financial system of the United Kingdom (UK), indeed, the entire global capitalist system, nearly collapsed, sparked by the U.S. Federal Reserve’s recent rate hikes and bond purchases:
On Wednesday [Sept. 28th], 30-year British government bonds swung more in a day than they had in a full year for the past five years — the biggest one-day move on record. In currency markets, the pound slumped to its lowest level on record against the U.S. dollar, coming close to parity, with moves of a magnitude comparable to the onset of the coronavirus pandemic.
“It is the most extreme market event that I have been involved in,” said Simon Bentley, head of U.K. client portfolio management at the asset manager Columbia Threadneedle, who started working in finance just before the dot-com bubble burst in 2000.
It all started last Friday [Sept. 23] when Kwasi Kwarteng, the chancellor of the Exchequer, announced Britain’s biggest tax cuts since the 1970s, predominantly for high earners… Fears that the government would have to increase its borrowing pushed down the price on its existing debt, and sank the value of the pound.
Prices move inversely to bond yields. Within 30 minutes of the British government’s announcement, the yield on 30-year government bonds, also known as gilts, soared, moving more than it typically does in a full day. The market reaction ricocheted around the world. U.S. government bond yields also rose, and stocks fell.
As turmoil increased, it exposed vulnerabilities in the financial system. Although investors initially sold off bonds because of the uncertainty, those moves caused upheavals among pension plans, amplifying the sell-off like a pileup.
Over the long term, interest rate swings can change the picture for pension funds. When interest rates rise, bond prices fall and pensions’ liabilities — essentially the money they owe retirees in the future — decrease in value. But when rates drop, the opposite happens, so the funds have to generate more cash going forward to cover their liabilities.
To guard against that risk, pension funds have increasingly turned to what’s called a liability-driven investment strategy, a way of using derivatives and other products linked to gilts that hedge against a drop in interest rates.
Derivatives work by tying their value to that of an underlying asset, in this case gilts [bonds]. And they are cheaper to purchase than the underlying bonds, so pensions can own more of them. That’s what the British pension funds did, building large positions that also made them more sensitive to changes in bond yields.
The strategy emerged in the late 1990s and grew in popularity as interest rates tumbled after the 2008 financial crisis. These complex financial instruments are structured so that the party on the other side of the trade would pay the pension fund when bond prices rose, but the pension fund would have to pay the counterparty when bond prices fell.
And that is what happened. When the pension plan’s bond prices fell, they suddenly became “on the hook” to the investment banks and hedge funds like the U.S. firm Black Rock, who demanded that the plans pay them billions, the difference between the previous bond value and the now devalued price of the bonds. Since the pension funds did not have that amount of cash, they went to the Bank of England for help. The Bank of England stepped in and announced that they would buy $65 billion in pension fund bonds over three weeks which settled the bond market down in the U.K. But the crisis showed how vulnerable the world capitalist system is in the face of bond and currency issues stemming from the U.S. Federal Reserve’s rate hikes and the British futile attempt to shore up the value of their own currency:
Now, as interest rates rise, these vulnerabilities are being tested. While this past week’s market moves were extreme, they came in a year of soaring government bond yields worldwide. The wild swings have raised worries about the fragility of the financial system, as well as questions over central banks’ ability to pull back from bond-buying programs that helped to soothe market turmoil during the pandemic.
“It’s a huge event for the U.K., but it’s also a huge event for central banks around the world,” said Sam Lynton-Brown, head of global macro strategy at BNP Paribas.
An Oct. 11 New York Times article titled “Bank of England Expands Market Intervention to Avoid a ‘Fire Sale’” indicates that the British financial system’s crisis is far from over:
The sharp rise in bond yields, especially for bonds with long maturities, left an investment strategy used by pension funds in disarray, as they were forced to sell bonds to raise cash for collateral. It was so bad that the Bank of England felt compelled to intervene by offering to buy bonds, and postponed its plans to sell off its debt holdings back to the market.
Initially, this helped bring bond yields down. But tumult has returned as traders wonder what will happen when the bond-buying operation ends on Friday.
This week there has been a “further significant repricing” of government bonds, especially for inflation-linked bonds, the central bank said on Tuesday.
“Dysfunction in this market, and the prospect of self-reinforcing ‘fire sale’ dynamics pose a material risk to U.K. financial stability,” it added in a statement.
European Continent in Crisis from Fed-Caused Financial Crisis and U.S. Proxy War in Ukraine
German electricity prices are 14 times higher than in 2021 and natural gas prices have jumped 240 per cent. A Sept. 28th Bloomberg newsletter included an article titled “Europe’s Recession May Mirror Financial Crisis”, which describes how dire the energy crisis is in Europe:
With a continent-wide recession now seemingly inevitable, a harsh winter is coming for Europe’s chemical producers, steel plants and car manufacturers that have joined households in sounding the alarm over rocketing energy bills. Building on a model of the European energy market and economy, the Bloomberg Economics base case is a 1% drop in gross domestic product, with the downturn starting in the fourth quarter. If the coming months turn especially icy and the bloc’s 27 members fail to share scarce fuel supplies efficiently, the contraction could be as much as 5% — a recession about as deep as the 2009 financial crisis. At the same time, Europe’s frenzied buying of liquefied natural gas [U.S is charging 4 times the global price] means it’s likely to have enough of the power-generation fuel to offset supplies from Russia, according to Bloomberg research. But just like the economic development, this will depend on how cold the winter gets.
An October 9th financial industry newsletter oilprice.com article connects the European energy crisis caused by the U.S. proxy war with the financial crisis sparked by the speculation in the energy commodities market, threatening the entire European finance system:
As Europe continues to grapple with a daunting energy crisis, European energy markets still face a liquidity disaster, with financial institution exposure to fossil fuels and record levels of margin calls sounding the alarm bells. [“Margin calls” refer to brokers demanding that investors put up more money to “protect” their derivative wagers otherwise known as “default swaps”].
According to Norway’s Equinor ASA (NYSE: EQNR), European energy trading is under severe strain by margin calls of at least $1.5 trillion, putting extra pressure on governments to provide more liquidity buffers.
Aside from fanning inflation, the energy crisis is sucking up capital to guarantee trades amid wild price swings. Energy prices have been fluctuating over such a broad range that many firms are now struggling to manage margin calls, making them demand additional collateral to guarantee trading positions while also forcing traders to secure multibillion-euro credit lines.
Wall Street is perfectly content to watch Europe’s financial system go up in flames, no matter the harm it does not only to the lives of working class families, but its own capitalist partners, if it allows it to maintain its imperialist hegemony.
China Freezes Energy Prices
In contrast to the capitalist panic unfolding in Europe and the U.S., socialist China announced the workers’ government price freeze. From an Oct. 10 article in the Beijing Xinhua newsletter:
China’s top economic planner said Monday that it would keep domestic gasoline and diesel prices unchanged due to the volatility of international oil prices.
The prices of gasoline and diesel fuel on the Chinese market will not be adjusted at this juncture, the National Development and Reform Commission said.
It urged the three major state-owned oil companies, namely the China National Petroleum Corporation, the China Petrochemical Corporation, and the China National Offshore Oil Corporation, to ensure the supply of oil products and the implementation of the country’s price policy.
China’s refusal to go along with the U.S. war drive in Ukraine, as well its working-class control of socially owned companies in determining energy prices as well as its scientific planning has made China more and more a target for “regime change” by Washington and Wall Street. China’s leadership describes their system as “Socialism with Chinese characteristics”. It is certain that its socialist success that has so enraged Imperialism and at the same time presents a beacon of hope for the worlds’ workers and oppressed.
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