The worst inflation in 40 years has now morphed into what appears to be a global banking crisis — all of which appears to be the result of bad government policies. Inflation is out of control because our government shut down the economy for Covid, thereby creating a huge supply shortage — then flooded the country with Covid stimulus money creating a huge demand for supplies.
Rather than implement pro-growth economic policies to increase supply, the Biden Administration has increased regulations and anti-fossil fuel policies (reducing supply further) while at the same time flooding the country with more government spending (increasing demand) — thereby inflaming inflation.
Leaving the Federal Reserve to fight inflation by itself, its only tool is to crush demand (with lower output, employment, production—and a lot more despair) with a rapid increase in its target rates from 0.25% to 5.00% in a year. However, after 15 years of rates near 0%, this rapid increase wreaked all sorts of havoc on the banking industry.
Banks must now compete with government-issued Treasuries that are paying 4%; they failed to increase their rates on deposits fast enough and started losing deposits. Banks also invested substantial sums in "safe government bonds paying 2%", and when the new bonds paying 4% came out, their old bonds dropped significantly in value. With deposits leaving the banks it created a liquidity problem for some, forcing them to sell their old bonds at substantial losses to generate cash—SVB incurred a $1.8 billion loss selling their bonds. In fact, banks are currently sitting on $600 billion in unrealized paper losses on their government bonds — a ticking financial time bomb.
The Federal Reserve has generated profits since 1916 but has lost $42 billion since September and will soon be insolvent — as it too had invested trillions of dollars in long-term bonds yielding 2% but now cost 4.6% to finance. The Federal Reserve Act of 2010 requires the Fed Board to avoid credit losses — but makes no mention of losses from interest-rate risk. So, is the Fed going to bail itself out?
Treasury Secretary Yellen said the banking system is sound, but that she was concerned about possible contagion. She then increased FDIC insurance to cover all deposits (not just those under $250,000). In Europe there was the Credit Suisse "merger" (read: collapse), and new concerns about Deutsche Bank in Germany. Contagion?
It appears that the Federal Reserve has painted itself into a corner as the entire global banking system seems to have become dependent on cheap money, and its sudden withdrawal may kill the patient. Inflation is also deadly if it morphs into hyperinflation. The Biden Administration and Feds need to get on the same page, and fast.
Steve Gardes is a certified public accountant (CPA) and certified valuation analyst (CVA) with over 40 years of public accounting experience.