Causing Contagion - The American Mind

Bank runs are a classic symptom of excessive central bank tightening. The Biden Administration unleashed the worst inflation since the seventies by throwing $3 trillion of transfer payments at U.S. consumers after the economy had already begun to recover from the COVID recession. Unlike the inflation of the seventies, though, credit expansion was not the culprit—helicopter money and supply constraints were at fault. The Federal Reserve blundered by tightening credit conditions when credit wasn’t the problem.

The result was a whipsaw in the valuation of bank balance sheets that eventually took down Silicon Valley Bank and Signature Bank of New York. The aftershock will be a persistent squeeze on bank lending and tougher credit conditions for U.S. business. The stress will extend to European and Japanese banks, who have to roll over $13 to $14 trillion of liabilities to U.S. banks arising from currency hedges on overseas holdings of U.S. assets.

Monetary tightening is the wrong medicine. Today’s inflation is due to expansive fiscal policy hitting supply constraints. The correct remedy is to stop pouring gasoline on the flames—as Biden proposes to do in his profligate $5 trillion budget—and to increase supply by removing obstacles to manufacturing and energy investment in the U.S. I offered a plan for restoring American manufacturing in a new Provocations essay for the Claremont Institute’s Center for the American Way of Life.

Unlike all previous periods of stress in the banking system, the quality of bank assets isn’t an issue in the regional bank runs of the past week. During the COVID epidemic banks loaded up on the highest quality assets—bonds issued by the U.S. Treasury and U.S. government agencies—as the government showered $6 trillion in stimulus money on American consumers. That pushed inflation to the highest level since the late seventies, and the Federal Reserve responded by raising interest rates, reducing the market value of banks’ bond portfolios.

Bank holdings of government debt nearly doubled between 2021 and 2022 to a peak of $4.5 trillion, as banks financed the lion’s share of fiscal stimulus. Bond prices move inversely with interest rates, and the Fed’s interest rate hikes wiped $341 billion off the value of banks’ hold-to-maturity portfolios of $2.6 trillion. Banks don’t have to book those losses unless they sell their securities. Investors feared that a run against deposits would force banks to sell bonds and recognize those losses. That turned into a positive feedback loop in the case of Silicon Valley Bank.

via americanmind.org

And there you have it. David Goldman.