Let’s call things like they are: years of government policy and the actions of the FED have created a major problem for the U.S. economy. This problem is not local; it is inevitably multiplied and expanded worldwide for an obvious reason: U.S. assets are essentially the only instrument of liquidity, the basis for evaluating economic exchanges, and the benchmark for settlement.
What is the problem? The extreme mismatch between production capabilities and consumer preferences. Political elites seek to maximize the loyalty of the population and increase the number of votes for themselves. This leads, among other things, to a continuous stimulation of demand, i.e., in fact, an expansion of credit and an easing of credit conditions. Demand that does not match productivity.
Credit itself is a natural way of exchange, increasing the utility for both sides of the exchange at the expense of the time lag: you will receive the same valuable good in return for the good given away, plus a little more, because you will return the value of the good later. During this time, you will have time to create more, dividing your efforts between your opportunities and commitments in the way that is most advantageous to you.
As we know, money is merely an instrument of confirmation that you are entitled to receive the value given away, and the more time you have given to the recipient of your good to return it, the greater the premium it will add to the value given to you. Thus money itself is a proof of credit, for any exchange of goods with a deferred return is credit.
What happens when you give away a good for a day, and receive a day later the value of your good with a premium disproportionate to its value and loan time? You are either extra happy or extra dissatisfied. Happy if you are rewarded beyond your expectations because the value of the good and the timing of the loan did not imply such a premium. Or you are dissatisfied if you are not sufficiently rewarded for the transferred value.
The rate of remuneration for credit is determined by the value, the term, and, ultimately, the consensus of the participants in the exchange, based on the practice of horizontal exchanges, that is, the market. Each good has a value, determined by its demand and the possibility of creation. Accordingly, the size of the premium is formed depending on the value of the good and the timing of its return. The market is the establishment and change of the value and size of the premium on borrowed goods, due to the results of a million free exchanges between economic agents, when the value and the premium are formed in the process of natural horizontal exchange.
Now let us imagine that someone intervened in such a natural system and voluntarily set a premium to be paid on the return of the good received. Let us also imagine that this premium exceeds or is much lower than the market value and does not correspond to the time of return and thus to the risks. It is obvious, even without this sort of consequence analysis, that this distorts the natural market mechanism.
What have the FED and the Government essentially done? For decades, for the sake of maximizing political benefits, the Government and the FED have stimulated demand, i.e., exogenously, without regard to the real value and price of assets, reduced the cost of credit for one purpose – to expand demand. But we understand that this means a mismatch between production possibilities and the growth of consumer desires. The problem was temporarily solved by globalization, but today’s geopolitical and civilizational erosions, resulting from state greed, put an end to this political paradigm: the provision of cheap goods is coming to an end. Consuming beyond production capacity and providing the economy with cheap money is no longer possible.
The current turbulence in the U.S. banking system is an absolutely logical consequence of the policy of stimulating demand and making credit cheaper. Banks are used to a flawed business model: partial provisioning and abnormally cheap cost of money. You don’t have to fear dangerous borrowers, you don’t have to rate them too harshly – give it to everyone and make money by scaling with low margins but great coverage in sales: even if only 51% of borrowers turn out to be solvent, you’re already in the black. That’s the casino business model.
However, when the growth of consumer preferences begins to critically outpace production capabilities, inflation is inevitable: there are many wants, but few opportunities. In order to try to correct the market distortion they have created, the FED and the government raise the cost of money, that is, they increase the lending rate.
An appreciation of the credit rate, that is, an increase in the premium that one agent must add to the return value of the good transferred to another agent, naturally slows down exchange and production processes, that is, makes credit less available and reduces its speed. Moreover, these processes depreciate assets – the accumulated and income-generating goods, i.e., the agents’ investments. If you purchased a good for $100 by borrowing it at 2%, and that good brings you 10% a year, your return is 8%. If the value of the loan is now 4% instead of 2%, the return on that good drops to 6%, which means that the good falls in value – its value has dropped.
So, it is obvious that with the increase in the rate, which the FED provides to fight the inflation it created, the banks get a distortion of all processes. They are forced to borrow money at higher rates because the cost of money is now higher, but they cannot significantly increase the rate on the money they lend because it is too expensive: the number and quality of borrowers is falling.
The assets of the buck, as I said, are depreciating: what was worth 100 yesterday is worth 80 today.
If you look at it from the side of depositors – clients – banks, the situation is mirrored. Deposit rates no longer reflect the value of money: depositors gave money at 3%, and now the money is worth 5%. At the same time, we remember that the rate set by the FED is reflected as much as possible in the rate of return on government obligations. Then, obviously, there is no point in lending money to the bank at 3%, when you can give it to the government at 5%.
There is an outflow of deposits. Contrary to the popular belief about bank-ranch, it is not due to rumors, panic, etc. It is almost always a consequence of the vicious greed of the state and the policies it pursues.
The fact that the assets of the banks are loans should not be overlooked. Loans as investments have different levels of risk and return. The most reliable and risk-free investments (but also the least profitable) were government debt obligations. Banks invested in them a significant portion of their liabilities as a safe exposure, at 1.5%. Now these assets have a yield of 3.5%, so the value of banks’ earlier investments has fallen sharply. At the same time, as I mentioned above, the deposits, i.e. liabilities, banks are forced to borrow at new rates, at least higher than those that were. As a result, the value of assets falls, the value of liabilities grows. The banking system begins to collapse.
What are the banks left with? Bankruptcy or sale. And here we are faced with a sophisticated robbery of investors and, in reality, of a productive and enterprising population.
When a bank is sold as a business, the buyer acquires its portfolio of assets and liabilities, i.e., essentially the bank’s business. The business has a valuation, and the buyer buys a shareholding in part or in full, at a certain price, which is formed based on the valuation of the business and market peers.
In our case, however, it is, as usual, non-market and outrageous. Problem banks are not sold as a business at the appropriate valuation of its real condition! A “portfolio” of assets and liabilities is sold, at a price that is not quite clear, but not a business, i.e. equity! This means that investors – participants in the share capital and holders of corporate debt – are left with nothing, with an empty crumpled box!
This is the kind of bank bailout scheme the government came up with! This is yet another arbitrariness of a bloated political bureaucracy, whose goal is the same: populism and momentary satisfaction of the desires of voters. Difficult decisions require an admission of error and a tough talk at the risk of being kicked out. The elites in power, the Democrats, obviously don’t want that.
This depositor bailout policy is a true Mafia strategy, where you create problems for the subject and then offer to solve them for your own reward. The government now presents itself as a miraculous savior, a government that seeks the welfare of all. This is a blatant lie and a scam.
We should not be deceived. The government is killing market exchanges, step by step, in which benefits are distributed in the fairest and most efficient way possible. The government is telling investors: it’s your business risks, you just invested in failed businesses that failed, you had realized risks, blame yourself, it’s capitalism.
That would all be true, because investing in corporate debt or equity is an investment anyway, which means investors take the risks. But in a market economy, it is the market risks that investors take on! Here, however, investors have received realized risks created by the government! The government has distorted and corrupted market mechanisms for years, and now that banks are under attack thanks to the perverse incentives and unfair rules of the game created by the government, it says: get over it, these are your investment market risks!
No, these are not market investment risks. This is a Leviathan that has risen to its feet, but is afraid of the crowd, and is looking for those on whom to dump its monstrosity: on investors and on business. It is at the expense of the most productive and enterprising this Leviathan exists, sucking all the juices out of them and throwing handouts to society.
This is exactly what we are witnessing now. And this is just the beginning.