Landing initiated by a banking crisis

 In Articles

By Chelton Wealth, March 27

  • Governments and central banks have unwittingly caused turbulence.
  • Be careful with deposits.
  • The curtain is falling for Credit Suisse (but not just because of increased interest rates).
  • When inflation eases, calm will return.

In recent years, governments and central banks have injected a lot of money into the economy. Some of that money was parked in the form of deposits with commercial banks while there was no demand for credit. In order to still make a return, government bonds, among other things, were purchased for it. Last year, interest rates rose sharply and with them, the value of those government bonds fell sharply. For commercial banks, these are paper losses, until the moment that depositors withdraw their money from the bank. Then those losses are actually realized. Because the central banks’ policy makes the remuneration on deposits lower than the remuneration on money market funds, especially professional parties who book money away from commercial banks. This makes such a bank vulnerable to a crisis of confidence, and thanks to the viral effect of social media, electronic banking can make it happen quickly.

Meanwhile, several banks had to be bailed out. This is while banks are in much better shape than during the Great Financial Crisis of 2008. Unfortunately, the turmoil was not limited to a few regional banks in the United States but also spread to the weaker brethren in Europe. Credit Suisse was an obvious name, because of its many scandals and billions in fines for criminal drug money and helping Americans evade taxes. Immediate cause at Credit Suisse were questions from the central bank in Switzerland about details in the financial statements. This was the reason for the first share price drop this year. A statement by a major shareholder that he did not want to expand his stake in a possible issue was followed by a further fall in the share price. Those share price declines combined with the uncertainty caused by the problems at regional banks in the U.S. also caused a run on deposits at Credit Suisse. The aid of 50 billion Swiss francs on March 15 was not enough to bring back stability. Efforts are now underway to force Credit Suisse into UBS, creating a bank too big even for Switzerland to save. Switzerland is no longer the world’s island of safety. Deutsche Bank — the breakaway from the Great Financial Crisis — is also under fire, although balance sheet ratios there have clearly improved in recent years. This is just as well because it is less easy for Deutsche Bank to find a merger partner.

The good news is that after the Great Financial Crisis, there are extensive roadmaps in place to save banks. The central bank provides temporary liquidity and thus implicit guarantees towards savers and depositors. Meanwhile, two-thirds of the quantitative tightening has already been reversed. Even stricter rules and higher capital requirements will follow to prevent a repeat, resulting in a brake on lending. The bad news is that central banks have been raising interest rates despite the turmoil in recent weeks when this is precisely what is causing the problem. Central banks are still moving in the opposite direction because inflation is still too high. Moreover, calling off an already-announced interest rate hike may signal that the banking crisis is much bigger. Here the pursuit of price stability conflicts with the pursuit of financial stability.

At the heart of the matter is the development of inflation. The moment it moves rapidly toward the 2 percent target, central banks can loosen the reins, and calm can also return to the financial sector. Inflation will fall sharply in the coming months as prices rose sharply in the second quarter of last year due to the Russian invasion of Ukraine. Meanwhile, energy prices have fallen sharply, there are far fewer logistical problems and one-time corona effects are also gradually disappearing, boosting the service sector in recent quarters. Moreover, it takes 12 to 18 months for the full effect of interest rate hikes to be felt in the economy.

Eventually, every central banker will argue in the face of the banking crisis that this is all and nothing else will happen. The problem is that there are so many unique cases that it is increasingly difficult to keep calm. Such financial accidents are a direct result of monetary policy. Virtually every series of interest rate hikes in the past, therefore, ended with a financial accident, and this time is no different. Last year it was already the British pension funds that had to be bailed out. Now it is the regional banks in the United States. As long as tight monetary policy continues, those who have taken on too much risk in the past — encouraged by negative interest rates — will be in trouble. Ultimately, this means that the central bank will have no choice but to stop tightening and even have to cut interest rates.

The banking crisis is accelerating the end of this monetary tightening cycle. According to Fed Chairman Powell, the current crisis is equivalent to one or two rate hikes. However, steering for a soft landing has become less easy. After all, there is now more turbulence. There is a chance that central banks will go too far in raising interest rates and cause a recession. Such a recession should not be compared to the two previous recessions this century that caused stock prices to halve. Then deflation was the problem; now it is inflation. For equity investors, inflation is more of a luxury problem, while inflation remains the great enemy of bonds. By all measures taken, the banking crisis is unlikely to cause an emergency landing on the economy, but the landing — hard or soft — has begun.

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