We are experiencing a trillion dollar rebalancing

The writer is an editor for the FT and writes the Chartbook newsletter.

Faced with a succession of banking crises, I would like to say plus this change. There is nothing more inevitable than death, taxes and bank failure. But what about salvation? State-sponsored takeover of Credit Suisse by UBS and hasty guarantees for all SVB savers just the latest in a recent series such actions. They suggest that we have entered a new era in which complex liquidation of financial bubbles politically unthinkable, and so the moral hazard and zombie balances accumulate.

Both of these interpretations are outwardly plausible. Put them together and you get a glimpse of an even greater balance, an imminent crisis and an equally imminent rescue, opening the way to even more leverage and risk.

But by focusing on the moral game of bad bank managers and weak oversight, they mischaracterize the drama we are living through. What defines our current moment is not bank failures or relatively modest bailouts, but the amazing macro-financial turnaround in 2020-2023. It started with mega-quantitative easing in response to the truly unprecedented shock of Covid-19 lockdowns. The combination of stimulus, supply chain disruption, and Vladimir Putin’s war in Ukraine caused the biggest surge in inflation in half a century, which was met not by monetary easing, but by the most comprehensive monetary tightening since the advent of fiat money. path

This is not the caseplus this changebut polycrisis. We wouldn’t be here if it wasn’t for the pandemic. And the reaction of the central bank is also new. They do whatever is necessary to prevent further infection from SVB, but on the bet they stick to their guns. Since early 2022, in the face of a market crash, the Federal Reserve has shown a resolve that few credited to them. Fed Chairman Jay Powell even hinted that one or two crises could help knock steam out of the economy. Of course, those who were counting on the Fed to ease their pain from huge losses on their bond portfolios woke up bitterly.

The SVB and Credit Suisse containment does include some element of government subsidies, but these transfers are tiny compared to the trillion-dollar balance sheet shift from bond investors to bond issuers brought on by rising inflation and interest rates after the pandemic. the rate goes up. ass David Beckworth, from the Mercatus Center think tank, in the US, the ratio of public debt to gross domestic product has fallen by more than 20 percentage points since the peak of the pandemic. This spectacular shift in the balance sheet between debtors and creditors is being driven by three forces: the recovery in real output from the Covid shock, rising prices and wages leading to higher nominal GDP, and a downward revaluation of bond stocks as a result of higher interest rates.

Back in 2021, we were still worried about how to deal with insurmountable levels of debt in a world of centuries of stagnation and chronically low inflation. Now indebted Italy’s nominal GDP is growing so fast that by the third quarter of 2022, its debt-to-GDP ratio has fallen year-on-year by almost 7 percent. While no one wants to appear to be celebrating an inflationary wave, we are living under a decent veil of silence in one of the most dramatic and powerful episodes of financial repression in history.

That’s what’s behind the trillions of dollars of unrealized losses on the balance sheets of financial institutions around the world. The figure would be even higher were it not for the fact that central banks, thanks to QE, are also large holders of government debt and thus share in paper losses. Aside from the narrative of helpless banks and regulators celebrating a bailout, the really systemic issue is how we see our financial institutions in this gigantic trillion-dollar rebalancing. That is what will define this historical episode.

While debtors benefit from inflation and debt repricing, they need to prepare for rising debt servicing costs. Those who did not renew their obligations in an era of low rates are now facing an interest rate clip.

But if we can adjust to higher debt service levels and avoid a string of banking crises, a one-time price shock will open up unexpected fiscal space. We must use this wisely. We need public investment to avoid the reactive cycle we’re stuck in and start anticipating the challenges of the polycrisis, be it in the area of ​​public health, climate change, or destabilizing geopolitics.

We also need to help the section of society that is at least well equipped to deal with these financially turbulent times. Those in the bottom half of the income and wealth distribution are witnessing great balance sheet shifts. They have few, if any, financial assets and pay relatively little in taxes. They have weathered the drama of Covid and its aftermath as a shock to jobs and a cost-of-living crisis. Unlike bondholders or investors, they are not represented by lobbyists. Their households are not too big to collapse.

But if those who run the system imagine that they can be ignored, that they are of no systemic importance, these elites should not be surprised by the waves of strikes and populist backlash that are bearing down on them.