Prepare for the worst, the economic collapse of Europe and the US is coming and this is what it will look like

We are about to experience a sovereign debt crisis caused by the energy crisis in Europe. It is quite likely that the next 6-8 months will look like this. Putin will weaken Europe even further by keeping us in short supply in retaliation to sanctions, causing prices to rise even more. This will cause a sharp rise in energy prices in Europe, which are a major component of the consumer price index - this will cause a sharp rise in inflation.

A view on the next development?

Let us give a gentle reflection.

As the CPI rises sharply, electricity prices are of course passed on to consumers. Finally, with the risk of civil unrest/revolution due to refusal to pay, the Eurozone government has two options:

  1. Give in to Putin, let him have Ukraine, and stop the sanctions to restore the flow of energy.
  2. Decide to impose energy price caps on consumers and "make up" the difference. To achieve this, the ECB must impose yield curve controls to keep sovereign bond yields flat and prevent the fragmentation of EU sovereign bonds.

Game theory makes me think that the West is too deep in this mess to give in to Putin and would rather print the difference. It is said that no government has ever voluntarily gone bankrupt through austerity. They always resort to pushing.

Printing the difference by managing the yield curve will cause the DXY to soar higher because 58% of the DXY is the euro. This dollar wrecking ball will cause emerging markets to potentially default on their debts, which will force them to sell their US bonds to buy US dollars to defend and protect their currencies, as they will understandably look to themselves. As the emerging markets start to sell US bonds to accumulate dollars to defend their currencies, US bond yields will skyrocket and cause systemic risks in the US markets, as everything will be priced out of US Treasury bonds. Something will break.

The Fed then has two options to fix it.

Swap lines with the ECB and BOJ /in July 2021 they launched a permanent swap line to facilitate this/. This will allow them to simply lend dollars via central reserves to these central banks, which will help lower DXY and stabilize sovereign FX markets.
They can then also use their new standing repo facility to provide overnight loans to stabilize funding/short-dated sovereign bond markets. The use of this swap line and repo operation has a net stimulative effect and will cause the DXY to fall and stabilize the markets /although I believe everything will be nuclear during this period as correlations get to 1 as institutional institutions de-risk to get their VaR in line/.

In conclusion, I think we are at the end of a major sovereign bond bubble and this energy crisis is the catalyst. The Fed will be forced to stimulate or risk a complete implosion of the monetary system.

I'd be happy for you to join in this reflection and expand on it with your insights and opinions.


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