That clucking noise you hear is the sound of chickens coming home to roost.

What we are experiencing today was birthed in the response to the 2008 financial crisis and accelerated by the response to Covid19. Emergency interest rates made sense in the immediate aftermath of the GFC as a means of getting the economy off the life support machine. So did a limited amount of QE to get some liquidity back into a system where credit had been well and truly crunched.

The problem is, free money is as addictive as any opioid painkiller. Politicians, businesses and investors gorged on it. Soon this was reflected in share prices, bond prices, property prices and even in collectibles like fine art and classic cars. Bizarrely, the Treasury even made money out of QE. The Bank of England mouse-clicked billions of pounds into existence on which it paid interest at the Bank’s own rate, i.e. almost zero. They used the money to buy government bonds which paid a higher coupon than the Bank’s own interest rate. The Bank is not allowed to keep these ill-gotten gains, it has to pay them to the Treasury.

What a nice little earner that has been for successive chancellors.  Between 2009 and September 2022 the Bank handed over £122 billion pounds in what are essentially arbitrage profits between the cost of money and the treasury coupons. How long does it take to form a habit? Thirty days? A couple of years? We can debate that for as long as we like, but it’s clear that, somewhere in the 2010s, politicians and economists lost sight of financial reality. The ‘emergency’ interest rates remained in place for over a decade, the cheapest money had ever been in all of history. The view formed that things would stay this way forever.

Learned economists of a left leaning philosophy invented the concept of Modern Monetary Theory, aka the Magic Money Tree. In essence, the theory is that with money almost free, if you can print your own currency then who cares how high your debts become? As long as you can meet the very low interest payments you can fund all the pet schemes and vote winning handouts that you want forever more. Governments around the world leaned heavily on this thinking when the pandemic started in early 2020. From furlough to bounce-back loans, stimmy cheques to CIBLs, trillions of new currency were clicked into existence in a matter of weeks.

This was way more than 2009, and there was a crucial difference in the money flow. Back then it went to the banks to revive their bombed-out balance sheets. This time it went direct to consumers. The Federal Reserve employs hundreds of Harvard educated economists. It seems that not one of them worked out that, if you shut down the economy and supply chains for two years while piling money into people’s bank accounts, when it all opens up again you might just have too much money chasing too few goods and services. Let me open up my copy of Economics for Dummies – ah yes, page 27. Too much money chasing too few goods equals = inflation.

Whoever would have guessed it? Yes folks, these are the technocrats who think they have their finger on the pulse. The people who think we are all too stupid to understand. So here we are in 2022 with forty year highs in inflation before any blame can be placed on Putin’s war in Ukraine. That simply added an energy crisis and food shortages to stoke yet more inflation to what was already baked-in by that well known comedy double act, governments and central banks.

Caught out by their own actions, how have central banks responded? By raising interest rates further and faster than ever before. Just like governments competed for how severe a lockdown they could impose on their citizens, central banks now out-do each other with the size and frequency of interest rate rises. In March of this year the Fed raised rates for the first time since 2018. It was a modest 25 basis points, taking the cost of money from a quarter of a per cent to half a per cent. Just two months later they came in with a whopping 75 to 100 basis point rise, at the same time saying they would start selling some of the bonds they’d been accumulating. One month later, June 2022, and another 75 basis point rise is announced. With US inflation north of 9% by July, yet another three quarters of a percent was added to the base rate. September saw another 75 basis points added with guidance that the rate would end up around 4.4% by the end of this year. One impact of all these rises has been a strengthening of the dollar against almost every other currency to the point where seasoned observers believe the greenback is now in a bubble.

The Bank of England has been slower to respond and more measured in its raises, at least until November when it implemented its own 75 basis point rise, the biggest hike since 1989.  This takes UK rates to 3% with further rises extremely likely. To throw some petrol on the fire, the scarily useless governor Andrew Bailey opined that the UK is heading for its worst recession in a hundred years. I take some comfort from the fact that pretty much everything Bailey says and does is wrong so hopefully we’re heading into the roaring twenties redux!

But there’s one important change that seems to be flying under the radar. Have you noticed that there’s been a bit less talk about Modern Monetary Theory in 2022? The reason is that the Money Tree has suddenly lost its magic. Here’s why. In order to combat the inflation that the government and the Bank of England have created between them, we’re seeing rapid rises in interest rates. This means that the Bank of England is now paying more interest on the money it created through QE than it is receiving from the £838 billion of government treasuries it still holds. In a reversal of the previous money flow, these losses have to be paid to the Bank by the Treasury. In the third quarter of this year, as the arbitrage trade went in the other direction, Jeremy Hunt has had to write a cheque to Andrew Bailey for £828 million. He and Rachel Reeves had better practice their signatures, because the estimate is that a further £133 billion will need to transfer from taxpayer funds in the Treasury to the Bank of England over the next five years. Funny, I don’t recall Jeremy Hunt mentioning that in his Autumn statement?

The Office for Budget Responsibility has been anxious about this for some time, pointing out that QE has increased the sensitivity of government debt to changes in the base rate. It estimates that a 1% increase in rates will increase debt repayments by £25 billion a year. Suddenly, all that debt accumulated in the free money era is about to get a lot more expensive. Total government debt now stands at around £2.5 trillion, just over 100% of GDP. It’s easy to see how quickly debt interest could become one of the biggest line items on the country’s budget. It already exceeds the entire education budget and with further rate rises in the pipeline the impact of QE on public services will bite harder and deeper than anyone seems to be aware of.

What’s to be done about it? Pressure is building to stop paying the banks interest on their reserves altogether, or to ease the pressure with tiered interest rates. This sounds attractive, but overlooks the fact that commercial bank reserves are a requirement of the Basel 3 liquidity rules. If they stopped earning money on these reserves, banks would focus elsewhere and let their reserves decline to the point where there could be a systemic liquidity risk. Not dissimilar to the recent crisis in the gilts market, wrongly blamed on Kwasi Kwarteng when it was really all about hidden LDI derivatives giving dangerously high leverage to supposedly rock solid defined benefit pensions.

What lessons can we high net worth investors draw from all this? One, financial markets are complex, multi-faceted beasts. Two, that the short term actions of politicians will usually have unforeseen long term consequences. And three, that the technocrats who seem to dominate governments in the 2020s are nothing like as smart as they would like us to think they are. The bottom line is that what I’ve been preaching for more than a decade is now truer than ever. We must take control of our own financial future as sovereign individuals looking after our own interests. Ideally, that should involve options on where to live and where to pay taxes. It also needs to involve independent money that cannot be corrupted by these two-bit technocrats. If you’re a certified member of the Beaufort community, watch out for an exciting announcement on how you can achieve this independent money next week.