SVB Collapse Shows US Monetary And Fiscal Goof-Ups Have Costs For World, Benefits For US

SVB Collapse Shows US Monetary And Fiscal Goof-Ups Have Costs For World, Benefits For US

by R Jagannathan - Tuesday, March 14, 2023 12:04 PM IST
SVB Collapse Shows US Monetary And Fiscal Goof-Ups Have Costs For World, Benefits For USThe collapse of SVB shows how badly managed US financial system is.
  • America is fortunate that the rest of the world is foolish enough to encourage it to mismanage its own economy and that of the world.

The collapse of two major banks last week in the US, Silicon Valley Bank (SVB) and Signature Bank, shows how badly mismanaged and mis-regulated the US financial system is.

Worse, it proves yet again how America never has had to really pay for its fiscal and monetary follies, even while imposing costs on the rest of the world.

One cost of the collapse of SVB, the US’s sixteenth largest, was seen almost immediately in the United Kingdom, where the local subsidiary of SVB was handed over to HSBC Bank for a nominal price of one British pound.

This implies that the ultimate cost of the bailout, if assets prove less valuable that the sum total of deposits, will be paid by HSBC.

There is, however, no immediate danger of that, as HSBC has a $3 trillion balance-sheet and, at last count, SVB (UK) had assets of 5.5 billion pounds against liabilities (deposits) of 6.7 billion pounds.

But it cannot be assumed that those assets are worth what they seem on paper.

Another cost to banks in general was a sharp fall in their shares, as investors fretted over SVB’s contagion effect.

To prevent the contagion from spreading to other weak banks, the US Treasury, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) announced that all deposits are safe — in effect giving federal guarantees for amounts even exceeding the insured amount of $250,000 per depositor.

While Uncle Sam is still talking about not letting the taxpayer foot the bills for the bailouts, if the contagion actually spreads to smaller banks in the US, nothing can be ruled out.

The Treasury has, anyway, put in place a $25 billion fund to cover any losses from a one-year line of credit to them to prevent a run on their deposits.

A precedent has thus been set in bailing out depositors beyond the levels of insurance provided by FDIC, and this ultimately means any widespread failure of banks will be paid for by the taxpayer.

Uncle Sam’s mismanagement is apparent at three levels.

The first failure is at the regulatory and supervisory levels.

When the 2008 global financial crisis was triggered by the Lehman collapse, it was largely the result of US regulators letting Wall Street 'whiz kids' create financial instruments whose risks nobody understood.

Worse, the US Fed allowed the stock markets to have a ball, aiding excess optimism and “irrational exuberance”.

But once Lehman happened, the Fed made money cheaper than ever.

Till 2022, the general assumption was that US interest rates would remain low, and SVB’s investments in US Treasury bonds turned out to be its nemesis when the Fed started raising rates sharply due to inflation fears.

Again, one wonders how the regulators could not see that vulnerable banks like SVB, with such large holdings of low-interest treasury securities, would not end up with asset-liability mismatches once rates zoomed.

In fact, this was exactly what happened, and last Wednesday (8 March), when SVB announced that it has incurred a $1.8 billion loss and needed more capital to address depositors’ concerns, the share value crashed by over $160 billion in just one day.

Little wonder, SVB is history.

Three failures in one here: monetary, fiscal and regulatory.

The second mismanagement was obviously during Covid, when the US government printed trillions of dollars to keep businesses afloat and to help poor people.

This flood of printed money effectively ensured that America would have the most virulent inflation in over four decades, forcing the Fed to raise rates aggressively.

This is poor economics, based on the assumption that you can print any amount of money and still manage to keep inflation low.

Rubbish theories like Modern Monetary Theory, which postulated that you can keep printing money as long as inflation was low, were floated just before inflation came roaring back.

Again, the same failures: complete lack of monetary and fiscal discipline.

Here's the reality: America mismanages Covid, as well as its fiscal and monetary policies, and it pays no real costs.

Its economy is booming, and unemployment is at a historic low.

India manages Covid well, both fiscally and through a massive vaccination programme, but it is the rupee that pays the price as US Fed raises rates.

Our inflation is a direct result of US economic mismanagement.

The third level of US failure, and directly related to the previous two, is over-dependence on sovereign borrowings at super low costs till recently.

America is a fortunate country in that it can print any amount of dollars and there is always someone willing to take it.

According to Christopher J Neely, Vice-President at the Federal Reserve Bank of St Louis, America benefits when non-US citizens hold large amounts of cash outside the US.

One estimate by the US Federal Reserve put this external dollar overhang at $1.1 trillion ($950 billion as in 2021), of which two-thirds may be in $100 notes.

Says Neely: “Foreign holdings of US cash also benefits Americans because those foreign users must get that currency by selling US residents labour, goods or services. If the cash never comes back to the US, then Americans have just exchanged pieces of green paper — which cost almost nothing to print — for valuable goods. This is a good trade for Americans. If the foreigner eventually uses the cash to buy goods and services from an American in the future — say in 10 years — then the foreigner has given America an interest-free loan for 10 years. This is also a good deal for Americans.”

Put another way, the rest of the world, by holding US currency, is actually helping Uncle Sam live beyond his means and mismanage his economy and cause harm all around.

Worse, if a large part of the $100 bills is held by drug cartels, criminal gangs and thugs, it implies that America is invulnerable to fiscal and monetary mismanagement as long as other people are willing to keep dollar notes and not bring it back to the US.

Little wonder, if there is a problem, the answer always is: print more greenbacks.

The US Fed knows this, and hence it seeks to always ensure that the dollar remains king in global trade and transactions.

In the past, the US Fed Chairman Jeremy Powell has repeatedly said that gold is not an alternative to the dollar, and that there is no conceivable replacement for the dollar as a reserve currency.

He has also been solidly against crypto currency.

America is fortunate that the rest of the world is foolish enough to encourage it to mismanage its own economy and that of the world.

Contrary to the generally accepted wisdom, that you can fool some people all the time, and all people some of the time, but not all the people all the time, Uncle Sam has just managed that feat for decades.

Jagannathan is Editorial Director, Swarajya. He tweets at @TheJaggi.
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