No More Easy Money

Money that comes easily disappears quickly, but money that is gathered little by little will grow. (Proverbs 13:11)

Are we headed for a ‘Minsky Moment’? A ‘Minsky Moment’ (named for the US economist Hyman Minsky) refers to a sudden market crash caused by a sharp fall in investor confidence, based on what Minsky called an increase in “speculative and Ponzi finance” which becomes obviously unsustainable. In other words – it’s a form of contagious panic. It might seem perverse to suggest this when inflation, relatively high interest rates and recession is all the talk.

But the massive injection of money into the global economy from Covid-19 support packages – put at $19.5 trillion by the International Monetary Fund (IMF) in 2020[i] - supported not just people’s weekly shopping but also an explosion in asset prices. A McKinsey report from 2021 says “net worth has tripled since 2000, but the increase mainly reflects asset gains in real assets, especially real estate”. The IMF says that real estate makes up two-thirds of global net worth.

Finance analysts are starting to suggest that the bursting of the bubble a la Minsky is now substituting for inflation as the bigger economic threat. Allianz suggests a Minsky is on its way, as does JPMorgan Chase; Bank of America’s latest global fund manager survey (published in March) found that 31% of 212 fund managers think that a systemic credit crunch is the biggest threat, followed by 25% thinking that stubborn inflation is more serious.

The Debt Burden

Debt, and the inability to bring debt levels down, yet the impossibility of servicing this debt, is edging the world towards its next Minsky Moment. The Institute of International Finance (IIF), the global banking lobby group based in Washington D.C., said last week that global debt rose to almost $305 trillion in the first quarter of 2023. “Global debt is now $45 trillion higher than its pre-pandemic level and is expected to continue increasing rapidly…heightened geopolitical tensions are also expected to drive further increases in national defence spending over the medium term” said the IIF. Added to higher defence spending are rising health care costs, costs associated with ageing populations, and extra burdens on governments pursuing climate change mitigation policies. In emerging markets the debt burden reached a new record high of more than $100 trillion, up from $75 trillion in 2019, with Brazil, China, India, Mexico, and Turkey largest contributors.

The IIF also issued a muted warning about the recent banking turmoil. It called the bank failures “more idiosyncratic than systemic” but added that worries over banks’ liquidity could result in a “sharp contraction in lending”, bringing about higher default rates, particularly in so-called ‘zombie’ firms (which earn enough to continue operating and pay interest on its debt, but not to pay off the debt itself), which it reckoned was around 14% of US companies.

The demise of SVB, which became a zombie in less than a week, was largely because the bank had invested in long-dated US Treasury and mortgage-backed securities bought before the Federal Reserve started raising interest rates; once that process began these securities became losses on paper on SVB’s balance sheet. The worry is that many of America’s other, small and regional banks are sitting on similar paper losses, which could be as much as $2 trillion. It took less than a week for SVB to fall. The US has more than 4,000 commercial banks, more than 10 times the next highest country, which is Russia. One academic study, published in March, found that 186 other banks are at risk of failure: “even if only half of the uninsured depositors decide to withdraw, almost 190 banks are at potential risk of impairment to insured depositors, with potentially $300 billion of insured deposits at risk. If uninsured deposit withdrawals cause even small fire sales, substantially more banks are at risk.”

Where did the money go?

There are differing estimates of how much governments spent on providing support during the Covid-19 pandemic; in the case of the UK the estimates range between £310-£410 billion, equivalent to around £4,600-£6,100 per person, with very little assessment of need. In the US, 'stimulus' payments reached around 85% of the population and by the end of 2021 Americans had more than $4 trillions extra in savings compared to 2020.

The waste of money is shocking; the House of Commons Public Accounts Committee said there was an “unacceptable level of mistakes, waste, loss and openings for fraudsters which will all end up robbing current and future taxpayers of billions of pounds.” Billions of Dollars were looted by fraudsters from the various Covid-19 support schemes in the US, so much that President Biden has proposed spending another $1.6 billion on investigating such fraud. The US Secret Service said at the end of 2021 that the amount stolen was a minimum of $100 billion.

Legitimate claimants and fraudsters alike benefited hugely from the trillions put in the financial system, first in the wake of the 2008 Great Financial Crash and then, scarcely a decade later, by Covid-19. Did this massive spending contribute to inflation? Intuitively one says yes, but there are few rigorous studies done so far. One, by the St Louis Federal Reserve argues that “fiscal stimulus during the pandemic contributed to an increase in inflation of about 2.6 percentage points…by stimulating demand without boosting supply, our results suggest that fiscal support contributed to increased excess demand pressures.” Other research from academics at Johns Hopkins University suggests that fiscal inflation, i.e. expanding the money supply, accounted for “approximately half” of price rises. The academics go on to say that “fiscal inflation tends to be highly persistent…When inflation has a fiscal nature, monetary policy alone may not provide an effective response.” The reckless spending and borrowing during the pandemic inflated national debts and helped spark inflation.

What are the take-aways from all this? There are several important points. The first is that many more banks in the US probably have unrealized losses on their balance sheets and are therefore vulnerable to a bank ‘run’, i.e. depositors fleeing with their funds before others try the same. If SVB, Signature and First Republic were naked when the tide went out, others are probably too. The boards of those banks are probably nervously hoping that no-one spies their exposure.

The second is that the Federal Reserve’s attempt to solve a fiscal crisis by monetary means is going to be unsuccessful precisely because it is attacking the problem – high rates of inflation – by using the wrong weapon, raising interest rates.

The third is that debt levels globally are vastly higher than the ability to repay; zombie companies exist everywhere, not just the US, and there are some zombie countries too.

The final point is perhaps the scariest – governments can splash the cash but they are not very good at directing where it goes, or controlling who gets it.