The Federal government has stepped in the Enron case, the Great Depression, in the Great Recession, and now we will be adding the time the Feds stepped in the SVB Bailout, or is it one?
Well, that’s up for debate because this financial event may be the most non-bailout bailout in American history. Let’s talk about the mess and a half that is the fall of Silicon Valley Bank and how it all connects to crypto and the wider financial markets as a whole.
When commercial banks fail, spooked central bankers slow down the normalization of monetary policy. This gives the liquidity overhang more time to turn into inflation, entrenching expectations. Interest rates may be lower in the short term as a result of banking crises—but they will be higher in the long run.
SVB’s Demise is Another Example of Financial Excess
After the 2008 global financial crisis, the US Federal Reserve added US$4 trillion, then added roughly the same again during the pandemic. All this money did not immediately lead to inflation—it stayed in the financial system, making it bloated and dangerous.
The causes of SVB’s failure are similar to those behind the recent pension funds crisis in Britain. The bank put short-term deposits into long-term bonds, and the so-called duration mismatch led to losses as interest rates rose.
This raises the question of how bank deposits should be guaranteed. SVB’s corporate clients were risk-takers. Bailing them out is like rescuing the people who gave money to rogue traders in 2008. It shows the lack of progress in financial supervision since then.
In 2008, the financial system threatened to take down the whole economy and was made whole again despite the speculative losses. When the corporate depositors in SVB said they might not be able to pay employee wages, politicians buckled. There are so many hidden moral hazards in the modern financial system that it is stacked against middle-class savers and taxpayers.
Government Bailout is “Robbing Peter to Pay Paul”
Rich people can profit from it by taking excessive risks, and if it all falls apart, they can pass the bill to the little guys. As a result of financial deregulation in the 1990s, billionaires have been created left, right, and center, while ordinary people have become poorer as the bill for each disaster was passed on through diluting money and/or raising taxes.
There will be more bank failures and bond fund blow-ups to come. Speculators believed interest rates would stay at zero forever and took crazy risks. Central banks have created a huge mess, and it scares them.
They have become slower in normalizing monetary policy. With the reversal of easing just beginning, the slowdown gives the liquidity overhang more time to work into inflation. This leads to higher and longer-lasting inflation, which will require higher interest rates to eventually contain it.
How Long Will Inflation Last?
It is estimated that the Federal Reserve will take up to seven years to reverse its quantitative easing. The banking crises will only mean it takes longer. Odds are, most of the liquidity will be left out there to stew inflation. The world is sleepwalking into 1970s-style stagflation.
Many argue that easy money doesn’t necessarily lead to high inflation, citing Japan’s case. But it is absurd to believe that unlimited money printing won’t lead to higher prices. Japan’s inflation is at its highest level in over 40 years; it also experienced high inflation in the 1970s.
Still, cultural differences matter, and northeast Asian countries do seem less inflation-prone. For example, Chinese households are clamoring to pay down their debts early. This behavior slows the velocity of money and lengthens the lag between base money expansion at the central bank and inflation.
Maybe we should take a lesson or two from our Korean and Japanese allies? I think so.
