Readers of this newsletter series will recall that countless times we have warned about major economic challenges ahead for the US and global economies. We stated many times that tough times are ahead and that the aviation community needs to be prepared for what is to come.
Our astute readers no doubt would have already noticed many indications in the wider economy that things are going south. Take the collapse of Silicon Valley Bank and Signature Bank, for example. These are important indicators that as the federal reserve raises interest rates this causes businesses and banks in particular to lose money. In our newly created On Aviation™ Podcast, we will be able to discuss the mechanics of this in more detail. However, for now, understand that when banks buy long-term bonds at very low interest rates and short-term interest rates begin to rise based on certain market conditions, the banks will start losing money on those investments. This can lead to either a liquidity problem, a solvency problem, or both.
Note also, that not only banks face challenges with increasing interest rates but companies as well. A large number of companies rely on debt to fund operating costs and investments. As interest rates rise – which is another cost for businesses – the cost of taking on and servicing debt becomes much more expensive and companies tend to be unable to either take on new debt or service the old ones effectively as they did prior to increased interest rates. This creates a slowdown in business activities which in turn affects job creation and the production of goods and services. For further reading on this, see our article, ’Debt: Its effects on the Aviation Industry’.
Therefore, as the title of this article states, ‘pay attention to the canary in the coal mine’. Banks and speculative sectors in the markets are generally the Canary because the speculative sectors – such as tech and real estate – generally take on more debt to achieve growth, and banks by their nature hold a lot of debt on their balance sheets to offset the deposits from depositors.
Now let us address the familiar question. What does this have to do with the aviation industry? As we have stated many times in this newsletter series, this will affect the aviation industry significantly. First, the activities described above lead to economic slowdowns, and economic slowdowns almost always affect the aviation industry. Second, the aviation industry does not operate in a bubble – though many of us think it does. It operates within the overall economy, and the businesses within the aviation industry are like any other that are affected by higher interest rates and economic slowdowns. Third and most importantly, the aviation industry, though robust in many ways, is paradoxically fragile and highly susceptible to economic shocks. As a result, any upset or downturn in the economy will be filled severely by the aviation industry.
In this article, we would like to share some insights Into what the recent bank collapse means for the economy, their causes, and what might happen moving forward. It is clear that other banks are in trouble and this problem is not yet over. In fact, many economists and market analysts believe this is the beginning of a major economic collapse that could lead to a deepening recession, or worse, an inflationary depression.
For more readings on economic challenges and the aviation industry, please see also: ‘3 Ways Aviation Businesses Are Coping With Inflation’, ‘The Aviation Industry and Economic Uncertainties’, ‘Inflation: Higher costs and their effects on Flight Schools’, ‘High Interest Rates/Cost of Borrowing and Their Effects on Aviation Businesses’,’Debt: Its effects on the Aviation Industry’, ‘Economic Crisis and the Aviation Industry’, ‘Inflation and Aviation’, ‘How The Aviation Industry Needs To Look At Inflation’, ‘The Aviation Industry Must Not Mistake A Recession’, ‘Understanding Recessions’, ‘Understanding Inflation’, ‘Money and Recessions.’, ‘Breaking Down Inflation.’ , ‘Inflation: Here we go again…’’, ‘Recession: Should we still be concerned?’, ‘Stagflation: Should the Aviation Industry be Concerned?’ ‘Aviation: Producer and Consumer Prices’, ‘Aviation: Are We In BIG Trouble?’, and ‘Aviation: Recession Red Flags?’
The failure of Silicon Valley Bank (SVB) on March 10 was the second largest bank failure in US history. Just two days following SVB’s collapse, Signature Bank joined the record books as the third largest bank failure in US history. First Republic Bank also seemed on the edge of collapse until Bank of America, Citigroup, and other big banks agreed to jointly fund a bailout for it.
Major Swiss bank Credit Suisse was also teetering on the brink when it received a 54 billion dollars line of credit from the Swiss UBS Group last week. Now, UBS is in the process of buying Credit Suisse. Politicians, regulators, and financial “experts” all rushed to assure us these problems were all caused by factors unique to the individual banks and were not a sign of a systemic weakness in the banking system.
The bank failures and near failures caused nervous banks to borrow a combined 164.8 billion dollars in one week from the Federal Reserve’s discount window and the Bank Term Funding Program, a new program created by the Fed to make loans to troubled banks. The Fed created this program even though supposedly there is no systemic problem in the banking industry.
While SVB didn’t receive a bailout, the Federal Deposit Insurance Corporation (FDIC) guaranteed the full amount of all deposits even though Congress set a standard FDIC guarantee on deposits of up to 250,000 dollars. By covering all SVB deposits, the FDIC has created an expectation among depositors at major financial institutions (as well as the institutions themselves) that the government will cover 100 percent of deposits. This will cause both depositors and banks to make investment decisions they typically would not make, thus guaranteeing larger bank failures followed by more bailouts for wealthy depositors.
Some have blamed the current bank failures, along with other signs that the economy is on the verge of a major downturn, on the Federal Reserve’s interest rate increases. It is true the Fed bears responsibility. However, the rate increases are not the problem. The problem is the “easy money” and low or zero interest rate policies the Fed pushed since the 2008 market meltdown, which was caused by the bursting of the Fed-created housing bubble. Federal Reserve manipulation of the money supply distorts interest rates, which are the price of money. This distorts the signals sent to market actors regarding the true value of investing in particular industries. The result is malinvestments in those industries creating a bubble. The bubble will inevitably burst.
The economic downturn that follows the bursting of a bubble is necessary to cleanse the economy of the malinvestments. The correction will not last long and the economy will emerge stronger if Congress, the Treasury Department, and the Federal Reserve refrain from “stimulating” the economy with federal spending and artificially low interest rates. Government interference, however, can create yet another bubble, setting the stage for another crash.
The new wave of bank failures is an indication that the US economy is either in or on the verge of another serious Fed-caused recession. With nations seeking to end the dollar’s status as the world’s reserve currency, the end of America’s disastrous experiment with fiat money, and with it the welfare-warfare state, could be on the horizon. The collapse can be accompanied by civil unrest and greater restrictions on liberty. However, the spreading authoritarianism can also spur a growth in the movement for individual liberty, a free market, and limited government that could make the dark night of authoritarianism a prelude to a new dawn of liberty.
Dr. Ron Paul is a former member of Congress and Distinguished Counselor to the Mises Institute.
This article was originally published in the Mises Wire on March 21, 2022, with the title “Are Bank Failures a Sign of More Trouble Ahead?. The views expressed are the author’s, and do not constitute an endorsement by or necessarily represent the views of On Aviation™ or its affiliates.
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Orlando – On Aviation™