Hey There Income Hunter,

The credit-based global financial system, at least on some level, should be called a Ponzi-scheme.

It’s for the simple reason that more and more people have to be added to keep it going.

Think about it this way …

Over the past 50 years, cumulative debt of developed countries has far exceeded the total currency supply.

And banks are the villains in this story.

Because when you deposit $100 in the bank, banks only hold 10% or less and lend the rest …

So, for $10 of currency in the system, they create $90 of debt.

Over time there is much less currency in the system than claims that can be made on that currency.

The answer, then, has been to print more currency.

Now Western central banks are pushing the envelope towards insolvency …

And today I’ll show you why this is the case and take a closer look at the bank in the worst shape of them all …

The Central Bank Dilemna

The chart below illustrates the US build up of debt, which really picked up after the country defaulted on its gold-backed dollar monetary system.  

Notice how the aggregate base money comes out to be one tenth of total debt due to the fractional banking system I’ve discussed recently here in Power Income. 

During the past four decades, the increase in debt was always offset by reductions in interest rates … This was by design so the cost of servicing that debt never really went up.

Eventually, however, major central banks all reduced rates to zero or even slightly negative

Any further debt increases at that point could not be offset by lower interest rates. This forced the cost of serving the debt relative to GDP to rise.

Today, significant setbacks in productivity due to reversing globalization or underinvestment in commodities have caused inflation to rise. 

This is what we are faced with now and the inflation is impossible to reduce completely because central bank’s can’t offset the rising inflation with large increases in interest rates.

Central Banks Are Officially Trapped

Here is what that looks like in the US:

We haven’t seen this level of disconnect between inflation and interest rates since the 1940s, which is the last time that sovereign debt as a percentage of GDP in the developed world was as high as it is now.

So, much like the 1940s, many developed market central banks are trapped.

• They can’t raise interest rates persistently higher than the inflation rate

• All they can do is slowly move interest rates higher …

• Talk tough about future moves …

• And try to inflate some of the debt away by using balance sheets to buy back bonds and hold interest rates significantly lower than inflation

US & Euro CB Balance Sheets

The Fed and European Central Bank have gone down similar paths by using their balance sheets to add more currency to the system. Notice the similarity in trajectory and outright levels. 

The ECB president Christine Lagarde revealed the dire nature of the situation last week during the ECB policy meeting …

Lagarde was asked what her plan was to get the balance sheet down …

All she could say was, “In due course it will come down.”

And then she smiled!

Why was that her only answer? Because neither the ECB, nor any other Western central bank, has a plan.

There is no way out of the mess they created.

Europe Will Be First to Fail

The Euro experiment was a nice idea but a monetary unity without fiscal unity was a very bad idea.

The problem is any single country, like Greece for example, cannot print money when needed or even influence the ECB to print money for them. This is in contrast to the US whose 50 states share fiscal union and monetary union.

The bottom line is this:

European countries need constant quantitative easing (QE) by the ECB in order to absorb the excess debt that each country is unable to sell at reasonable interest rates.

Italy and Spain Spreads to Germany Soaring

Italy and Spain have not been able to sell debt to private investors for many years and now rely on ECB purchases all of their debt via QE.

This situation is made worse by the energy crisis caused by the sanctions put on Russia, which caused a de facto Russian oil embargo on Europe.

Europe’s energy security could be under pressure in the summer during peak energy demand season and then again next winter.

This is a major issue to watch and also may create some excellent trade opportunities.

Bring It Home

You may have noticed some wild swings in the US Dollar Index (DXY) lately. This is being fueled in large part by the Euro, which has the largest weighting in the DXY.

The Euro did, however, put in a double bottom this week, but the bottom may not hold. There is no easy fix for Europe and, so far, the only answer is print more money and cap interest rates.

Lagarde may find a creative way to put a different label on it, but it is what it is

Watch the euro closely. A new low in the euro versus the US dollar signals another leg down in the euro.

Traders can trade the euro/USD via the Invesco Currency Shares Euro ETF (FXE). FXE has options and liquidity is decent. Here is the chart …

A bearish strategy on a rally to 98.22 or a break below 95.90 is one way to take advantage of the situation where the ECB finds itself. 

The relief valve when facing this situation is always the currency – just look at the Japanese yen … and eventually the US dollar will face a similar fate. 

Stay Tuned and As Always …

Live and Trade With Passion My Friend,

Griff