By Michael Every of Rabobank
A textbook case of mismanagement
“A textbook case of mismanagement” is how the Fed Vice Chair responsible for bank supervision is going to describe SVB when he testifies to Congress today. He will also stress the Fed is prepared to use “all of our tools for any size institution, as needed, to keep the system safe and sound.” While reassuring to some, to critics that will sound like a textbook case of mismanagement of moral hazard that ends up in future financial crisis headlines and further Fed bailouts.
Indeed, @JackFarley96 fintwits: “On July 16, 2019, The Federal Reserve & FDIC received a letter warning them about issues with US regional banks and their potential failure. The letter was sent by a group of senior central bankers and regulators, including Paul Volcker, Sheila Bair, and Jean-Claude Trichet, and Sir Paul Tucker, the then-chair of The Systemic Risk Council. Tucker had this to say to me last week: "in 2019 the Fed and the FDIC effectively decided to formally cease resolution planning for large regional banks.”” Who is going to be pointing fingers at whom today?
As Philip Marey covers in his latest report on the Fed (‘It gets cloudy after the pivot’), “The banking turmoil has strengthened markets’ belief that the Fed is going to cut rates before the end of the year. However, the implied policy rate path should be taken with a grain of salt, as the uncertainty about the rate path has increased substantially. So markets are pricing in a stronger pivot, but the exact rate path has become less clear.” That lack of clarity may have played a role in the ugly 2-year US Treasury auction yesterday, which also smacks of a textbook case of mismanagement – unless the Fed wanted to confuse markets about the rates path ahead.
Meanwhile, we see mismanagement of data in market analysis. For example, Bloomberg just stressed that Fed support for banks, if not via rate cuts, implies either balance sheet expansion (QE, not QT) or credit easing via liquidity support (so acronyms). Rate hikes and acronyms: who knew this could happen?! The point made is that all three are bad for the US dollar. Which is true: but they are worse for everyone else in the same boat!
ECB data show February, i.e., pre-crisis, already saw record deposit withdrawals from Eurozone banks due to rising rates. This went into money market funds or bank bonds, which does not smack of a lack of confidence – but it still says the cost of capital is going to increase. Moreover, Reuters says ‘ECB tells banks to cut lending to indebted borrowers after binge’, noting: “The ECB has told banks to cut lending to the most indebted borrowers, which could poke a hole in their balance sheets if the economy turns south or interest rates rise…. Leveraged transactions have grown to a EUR500bn pile on the books of the Eurozone's 28 largest lenders from EUR300bn in 2018 as record-low interest rates made banks seek returns in riskier parts of the market.”
In Australia, Westpac CEO Peter King, speaking at a local banking summit, stressed the issue for struggling mortgage holders is the duration of higher rates. In other words, everyone will tighten their belts and eat less smashed avo on toast in 2023 to keep up their home loan payments; but if rates don’t start falling back in 2024 then things start to look ugly: one can also point to the UK, or Canada, or New Zealand, or just about anywhere and say the same kind of thing. Given three of the four key Aussie datapoints the RBA is looking to before its next meeting have been strong or in-line, with retail sales up 0.2% m-o-m today as expected, and only CPI to follow tomorrow, then 25bps in April looks baked into the cake for now.
In short, it’s not just the US with issues related to higher rates on big piles of rate-sensitive lending; and it’s not just the US who will have to find either traditional or hybrid solutions. It’s still likely to be the ‘least dirty shirt in the dirty laundry basket’.
On those hybrid policy responses, Monday saw the perfect headline underlying the geopolitical reality now leaning on economics and markets which this Daily tries to hammer home. Norwegian ammunition manufacturer Nammo is complaining it can’t up production because a new TikTok data center is using up all the spare electricity in the area. They literally say: “We are concerned because we see our future growth is challenged by the storage of cat videos.” That’s a ‘guns or butter’ political-economy choice that a single interest rate isn’t going to help: too high, and you get neither guns nor ‘butter’; too low, and you only get ‘butter’.
Of course, in the case of TikTok one could just ban it, as the US Congress seems increasingly likely to do given the head of the US spy agency publicly calls it a “Trojan horse”. However, that’s as political-economy as it gets too: closing off some forms of ‘butter’ by fiat. As is the US regulatory attack on crypto platform Binance. This Daily has long argued the US authorities were ultimately likely to do unto crypto what FDR did unto gold in the 1930s, i.e., regulate it away as a real dollar rival. It was a textbook case of mismanagement to presume otherwise.
Yet a larger game is afoot. The Saudis making a huge investment into a new Chinese refinery and Riyadh accepting payment for USD-priced oil from Kenya in Shillings (as Kenya’s president states: "I will give you one piece of advice, forget the dollar. This market will soon change fundamentally. We don't need dollars anymore.") testify to a textbook case of White House foreign policy mismanagement. Even CNN and Fox News are now worrying about the end of US dollar hegemony as we shift towards more global barter priced in US dollars and cleared in third currencies. (For now.)
Yet the end of US dollar hegemony can’t happen unless the US, and the US alone, mismanages its economy on a far more epic scale than it currently is: and history shows a major war is usually required too.
The latter is a topic of conversation, as the Financial Times notes the worrying symmetry with the 1930’s in the Japanese PM’s recent visit to Kyiv as Xi Jinping visited Moscow: if you think the rates outlook is cloudy now, try looking at those dark storm clouds on the horizon. Maritime-executive.com, linking both points, op-eds that ‘To Prepare to Fight, China is Studying America's WWII Pacific Campaign’, stressing (as we did back in 2021’s ‘In Deep Ship’) that control of maritime logistics, i.e., supply chains, and the ability to disrupt them, are of critical importance.
Combine that with The Economist cover last week being ‘The World According to Xi’, with Russia, Iran, and Saudi Arabia orbiting a Chinese planet (in response to which I was asked: “Where is the German satellite?”), and the Indian chief of army staff delivering the keynote at a conference on China's Rise and Its Global Implications in which he called it "totalitarian" and "belligerent", and one is left saying ‘tick tock, tick tock’ not just TikTok. (Which India already banned.)
Meanwhile, on the US as uniquely problematic, all Western economies have their own issues. Saudi Arabia is building a giant cube 400m * 400m * 400m giant gold cube filled with a central TV screen. (Really.) And as some flag Jack Ma visiting China and Bloomberg stresses “Beijing extended its efforts to court foreign investment,” promising it will “unswervingly” open up a “broad space” for foreign firms, Henry Gao argues ‘Beijing’s Regulatory Crackdown Is Unlikely to End Any Time Soon’, underlining: “the types of businesses pursued by digital giants such as Alibaba are now regarded as “unhealthy,” or more specifically, not in line with the industrial policies of China…. Bias for heavy industrial development is reaffirmed by Xi’s party congress report, which emphasizes that the key focus of economic development should be the “real” economy, that is, only the industrial and agricultural sectors. The tertiary sector --services-- is almost ignored in his report. When mentioned, it is only considered to be a supplementary activity “deeply integrated with advanced manufacturing and modern agriculture.”” He concludes the next Beijing target is finance – which means a hybrid monetary-fiscal-regulatory-industrial policy.
Moreover, Gao elsewhere points out new State Council Working Rules show its ‘guiding thoughts’ section has deleted all previous references to Marxism, Leninism, Mao, and Deng, the Three Represents, and the Scientific Development Outlook, and keeps only Xi Jinping Thoughts on Socialism with Chinese Characteristics in the New Era. One might think that worthy of a market comment or two: but of course the market never read or understood any of the above anyway - or maritime-executive.com.
Furthermore, the new working rules state all major decisions and problems must be reported to the CCP Central Committee first; all State Council members shall resolutely implement the decisions of the Party Central Committee, and refrain from speech and behaviour that contradicts the decisions of the CCP Central Committee; and leading comrades of the State Council do not publicly publish books and speeches, do not send congratulatory letters, congratulatory telegrams, inscriptions, or prefaces. Gao concludes: “Li Keqiang might be the weakest Premier compared to the ones before him, but he will be the strongest Premier compared to everyone after him.”
Against this kind of backdrop, huge potential volatility awaits. For example, Kyle Bass again claims: “The Hong Kong Dollar is on the precipice of disaster. It broke through the weak side of the peg at the open today due to the beginning of significant capital outflows from global fiduciaries that have been forced to re-underwrite the danger of investing in China. SVB - a lesson.” Of course, the rebuttals to this are various and vocal.
To conclude, is everywhere seeing a textbook case of mismanagement all at once, or just some – or none? And what does the world look like on the other side of the currently cloudy outlook? I suggest our current textbooks will be on fire, for a start.