The author is an FT editor and writes the Chartbook newsletter
In the face of a series of banking crises, it is tempting to explain plus ça change. Nothing is more inevitable than death, taxes and bank failures. But what about the bailouts? It’s the publicly subsidized takeover of Credit Suisse by UBS and the hasty guarantee extension for all SVB depositors just the latest in a new series such actions. They suggest that we have entered a new era in which a thorough liquidation of financial bubbles is politically unthinkable and moral hazard and zombie balance sheets are piling up.
Both interpretations are superficially plausible. Put them together and you have a vision of ever-growing balance sheets, inevitable crises, and no less inevitable bailouts, paving the way to even greater leverage and even greater risk.
But by focusing on the moral game of bad bank managers and lax oversight, they mischaracterize the drama we are living through. What defines our present moment is not the bank failures, nor the relatively modest bailouts, but the amazing macro-financial turnaround of 2020-2023. This began with mega-quantitative easing in response to the truly unprecedented shock of the Covid-19 lockdowns. The combination of stimulus, supply chain disruption and Vladimir Putin’s war in Ukraine triggered the biggest surge in inflation in half a century, which was met not with monetary easing but with the most sweeping monetary tightening since the beginning of the paper money era.
This is not a case of “plus ça change“, but the polycrisis. Without the pandemic we wouldn’t be here. And the central bank’s response is also novel. They are doing what is necessary to stave off further contagion from SVB, but on rates they are sticking to their guns. Since early 2022, the Federal Reserve has shown a determination in the face of a market crisis few believed it could. Fed Chairman Jay Powell even hinted that a crises or two could help take the steam out of the economy. Certainly those who are counting on the Fed to ease their pain from huge bond portfolio losses have had a rude awakening.
While containing the fallout from SVB and Credit Suisse involves some element of public subsidies, these transfers are tiny compared to the trillion-dollar balance sheet shift from bond investors to bond issuers that has been triggered by post-Covid inflation and interest rate build-up . As David Beckworth, of the think tank Mercatus Center, has pointed out that in the US the ratio of public debt to gross domestic product has fallen by more than 20 percentage points since its pandemic peak. This spectacular balance sheet shift between debtors and creditors is the result of three forces: the rebound in real output following the Covid shock, the rise in prices and wages inflating nominal GDP, and the downward repricing of the bond portfolio as a result of higher interest rates.
As late as 2021, we worried about how we would deal with insurmountable levels of debt in a world of secular stagnation and chronically low inflation. Now the nominal GDP of indebted Italy is rising so fast that by the third quarter of 2022 the debt ratio has almost fallen compared to the previous year 7 percent. Although no one wants to be seen celebrating the wave of inflation, under a decent veil of silence we are witnessing one of the most dramatic and powerful episodes of financial repression of all time.
This is behind the trillions of dollars in unrealized losses on the balance sheets of financial institutions around the world. The number would be even higher if central banks, thanks to QE, are also large holders of government debt and thus participate in paper losses. Beyond the narrative of helpless banks and bailout regulators, the truly systemic question is how we view our financial institutions through this gargantuan trillion-dollar realignment. That will define this historical episode.
Although debtors benefit from inflation and debt repricing, they must brace themselves for the rising cost of servicing debt. Anyone who has not extended the term of their liabilities in times of low interest rates is now facing an interest rate cliff.
But if we can brace for higher debt service and avoid a spate of banking crises, the one-off shock in price levels will open unexpected fiscal space. We must use this wisely. We need public investment to escape the reactive cycle we are caught in and to anticipate the challenges of the polycrisis, be it in public health, climate change or destabilizing geopolitics.
We must also relieve that part of society that is least equipped for these financially turbulent times. Those in the bottom half of the income and wealth distribution are onlookers at the big balance sheet shift. They have few, if any, financial assets and pay relatively little tax. They have experienced the drama of Covid and its aftermath as a shock to jobs and a cost of living crisis. Unlike bondholders or investors, their interests are not represented by lobbyists. Their households are not too big to fail.
But if those who run the system believe they can be ignored, that they are not essential to the system, these elites should not be surprised by the strike waves and populist backlash that is coming their way.
Source : www.ft.com