A security guard looks out as customers line up at Silicon Valley Bank’s headquarters in Santa Clara, California, on March 13. Photo: AFP
Opinion
Andy Xie
Andy Xie
With Silicon Valley Bank bailout, an unrepentant US is spending its way out of trouble again
Expect more banking and bond fund blow-ups with the US reluctant to stop the endemic moral hazard in its financial system, preferring to lean on the dollar
As spooked central banks ease up on monetary tightening, inflation will only rise higher and last longer
When commercial banks fail, spooked central bankers slow down the normalisation 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.
The failure of Silicon Valley Bank (SVB) is just the latest example of the financial excess. After the 2008 global financial crisis, the US Federal Reserve added US$4 trillion in quantitative easing, 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 may 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.
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 centre while ordinary people have become poorer as the bill for each disaster was passed on through diluting money and/or raising taxes.
Customers waiting in line outside a branch of the Silicon Valley Bank in Wellesley, Massachusetts, US, on March 13. Photo: Reuters
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 normalising 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.
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.
01:41
Inflation at 41-year high in Tokyo as food prices soar across Japan
Inflation at 41-year high in Tokyo as food prices soar across Japan
Still, cultural differences matter, and northeast Asian countries do seem less inflation-prone. For example, Chinese households are clamouring to pay down their debts early. This behaviour slows the velocity of money and lengthens the lag between base money expansion at the central bank and inflation. Japanese and Koreans behave similarly under similar circumstances.
Meanwhile, the West is at the other extreme. While the US has by far the highest national debt per capita among major economies, most of its households live from pay cheque to pay cheque, including a significant proportion of high-income households. It reflects a preference for high consumption and low savings. Such households have a limited capacity to withstand shocks such as a recession or pandemic.
Their government has to bail them out by running fiscal deficits, backed by loose monetary policy. A fiscal deficit is the shortest path between money supply and inflation. Just like in the 1970s, the US is likely to be the epicentre of inflation this decade.
“The dollar is our currency, but it is your problem,” John Connally, US Treasury secretary in the Nixon administration, said to his European counterparts in 1971. Today, the US economy is no longer as powerful. China is the dominant trading and industrial economy. East Asia makes most of the world’s tech goods. The US depends on East Asia for consumer and tech goods, as well as deficit financing. The fundamentals for the dollar are a lot weaker than in the 1970s.
The spillovers from an excess dollar supply are largely held by central banks in East Asia and the Middle East, and by ethnic Chinese inside China or outside for currency diversification. Without their demand, the US government would have less room to solve its problems by printing money.
02:30
Silicon Valley Bank collapse stuns tech firms around the world, global operations dismantled
Silicon Valley Bank collapse stuns tech firms around the world, global operations dismantled
Even though US strength has declined, the dollar remains dominant. This is largely due to Beijing’s unwillingness to open up its financial system to the world. China isn’t an alternative to store savings. And, as its currency is pegged to the dollar, its economy supports the dollar’s global dominance.
The US seems bent on taking advantage of the dollar’s special status to spend its way out of problems. Bailing out SVB’s depositors is the latest example. From the 2000 dotcom crash, 2008 subprime blow-up and recent spreading bank failures, the US has shown no willingness to bite the bullet and stop the endemic moral hazard in its financial system and beyond. When the international world finally gives up on the dollar, it will be too late for the US to change.
