The alarm, unheeded, was probably sounded last September when the Bank of England had to intervene massively to support the value of its public debt, in free fall due to the government’s foolish fiscal policy decisions, which undermined the system’s liquidity.
A comparison could therefore be made with 2008 in the USA, when the bankruptcy of Bear Stearns, in the spring, preceded the collapse of Lehman Brothers by a semester, triggering the global banking crisis. But this experience has taught the monetary authorities a lot, so the FED’s reaction to the California SVB crisis was immediate and decisive, therefore no comparison could be made with what happened 15 years ago. The problem, denounced here on several occasions, must be traced back to the global debt of the world’s system, today equal to about 350 trillion dollars, compared to a global GDP of about 100 trillion dollars, which every year requires a refinancing of about 70 trillion, just to roll over the maturing debt. This is why the phase of credit tightening initiated by the central banks beginning in December 2021 materialized only through a sharp increase in the level of key rates, while in terms of balance sheet totals of central banks, the reduction turned out to be marginal, because this quantity is directly linked to the liquidity available in the credit systems.
However, despite its minuteness, the liquidity drain has provoked the mini US banking crisis, which in turn represents a wake-up call for what could happen to international banking systems if monetary policy tightening is not immediately abandoned. In this regard, it should be noted that the recent data relating to the aggregate liquidity of the primary world central banks show substantial stability, confirming that no systemic risks are perceived. In detail, the FED and the Bank of Japan have added liquidity, in fact the Fed has increased its balance sheet by 300 billion dollars, the Chinese bank has resumed a timid stimulus intervention, while the ECB and the Bank of England remain restrictive. The FED’s prompt reaction to the potential crisis resulted in the Term Bank Financing Program (BTFP), which now allows banks to access the FED’s counter to obtain unlimited funding up to 12 months, previously the term was 90 days, at the base rate plus 10 basis points, therefore around 5%, by depositing US government securities as collateral which the FED values at nominal value and not at market price. In fact, the insolvency crisis of the SVB was caused by the bank’s need to sell government bonds at a loss to satisfy account holders, eroding the institution’s equity base. To date, non-systemically important banks in the US hold about 1 trillion in government bonds, so the Fed’s balance sheet could soon increase by this amount. If, out of delirium of hypotheses, even the 15 systemically important banks were to access the BTFP, then the balance sheet of the issuing institution could grow by more than 50%. So, the central bank no longer acts as a lender of last resort but rather as a buyer of last resort of unlimited quantities of sovereign debt, which is equivalent to having substantially nationalized the banking system. In light of the recent crisis of confidence regarding Deutsche Bank, the ECB can only follow the same path. This solution, which has the undoubted advantage of definitively reassuring account holders, however, entails an unsustainable medium-term cost for banking institutions. In fact, if funding at the FED costs 5% and the yield on the 5-year government bond is 3.4%, a loss of 160 basis points is recorded annually.
So, the central bank has to use a hitherto uncommon monetary policy tool, yield curve control (YCC) which we have already referred to here in the past. To date, this instrument has been used continuously since 2016 only by the Bank of Japan and more recently by the Bank of England and Australia. In this case, the FED will have to gradually slope the yield curve in a positive way so that short term bonds yield less than the long bond and therefore the rate spread becomes positive for the banking system. It involves buying short-term government bonds by financing themselves with the sale of long-term bonds, with the ambitious goal of bringing the former to the 4% area and the latter to 5%. It will take time, 12/18 months, and imponderable economic factors could hinder the use of this instrument, consequently it is advisable to invest only in the short-term securities denominated in dollars.
Nicola Bravetti Data Source: Bloomberg
“This report cannot – nor can – be considered a solicitation to invest in financial instruments”