It is evident, when the system is viewed against the backdrop of the logic of financial capital in the context of the U.S. boom-bust-bailout economy alone, that it requires the ad hoc intervention of states and central banks for its continued existence, although this moment of sovereignty also repeatedly proves disappointing in its successes. Financial capital continues to show such extremely strong dynamics that the Schmittian moment of sovereignty fails, so that the next round of accumulation is initiated, which from a certain point on again requires ad hoc interventions. Uncertainty could thus actually escalate into the catastrophic.
Like the insolvent Silicon Valley Bank (SVB), U.S. and European banks and financial institutions have long bought government and corporate bonds issued at very low interest rates. Investors (e.g., Silicon Valley billionaires, asset managers, hedge funds, private equity, etc.) purchased these assets and used them as collateral to increase borrowing.
It is always the same cycle. It is important to keep in mind that the expansion of credit creation by private banks is now an important resource for speculative capital, which fuels the derivatives markets and may or may not also fuel the real economy. The expansion of credit leads to increased investments of money in derivatives, whose valuations increase as demand increases; the derivatives, which have increased in price, then in turn serve as collateral for further credit, setting in motion a feedback loop in which credit increases positive asset valuations and, at the same time, assets as collateral increase credit. The illusion of the eternal ecstasy of liquidity expansion implies that the leverage of monetary capital to purchase assets that serve as collateral for further loans remains the ultimate for notional and speculative capital. In this regard, derivatives markets must be profitable, liquid, and volatile enough for financial firms themselves to invest speculative capital, but firms must know how to avoid the point at which the elasticity of volatility can become dangerous to themselves: Derivatives markets are effectively creating the disease against which they must immunize themselves.
Since last year, central banks have replaced quantitative easing policies with tightening. The Fed faces a dilemma: If it tightens monetary policy too much and raises interest rates too quickly, it could cause the cost of borrowing to rise, so new investment in technology declines, credit-driven consumer demand for products stalls, and there is a general economic downturn. However, if the central bank does not act, that is, reduce its monetary injections and raise interest rates, then high inflation may not be temporary at all. Although raising interest rates alone will not fight inflation either. It should be sufficiently clear by now that any money creation program, which is desperately needed to prop up the financial sector, can combine with inflation to further erode purchasing power, requiring new creative methods to control the impoverished masses. The alternative to the cheap money scenario would be for central banks to raise interest rates until the market bubbles burst. The result of delirium in the dilemma is that the Fed is looking for a middle ground. The same is true for the Bank of England and the European Central Bank.
So the world’s central banks have responded to the possibility of a coming crisis, positively influenced by the Russian invasion of Ukraine and then by speculative and inflationary developments in the global energy and food markets, by tightening further, which also means raising interest rates further, thereby dampening economic activity (employment, investment, etc. ) domestically, depressing real wages and triggering a recession, – in the hope that a collapse in economic activity domestically will lower price inflation (but mainly set in the largely deregulated and speculative global financial markets). Since a domestic response to a global phenomenon (energy price inflation) cannot be regulated by central banks, government and corporate bond markets, as well as equity markets, moved lower in 2023, recognizing that higher interest rates do not lower global energy and food prices, but rather just primarily lead to a domestic recession. It should be noted at this point that in financial markets, not only does volatility drive illiquidity, but illiquidity begins to cause volatility. When both effects occur simultaneously, a cycle can occur in which volatility rises and liquidity collapses.
Professors like Larry Summers and Ken Rogoff argue that inflation trumps all other threats. And that inflation is largely caused by rising wages, or even the expectation that wages might rise. To suppress wages, and thus inflation, central bankers must aggressively increase the money supply, even if it depresses demand, increases unemployment, and further lowers wages. But inflation is caused primarily by speculation in the commodity market, not wages, in addition to supply shocks in global supply chains as a result of Corona. Now, if workers and employees are demanding higher wages to offset the inflationary effects of higher energy and other commodity prices, this is a consequence, not the cause, of the energy price inflation that regulators are failing to control.
To the extent that inflation lowers the value of debt, the assumption is probably to defend the interests of creditors against borrowers. Inflation allows borrowers to repay a loan with money. High interest rates, which supposedly fight inflation, but also reduce income of debtors can lead to defaults, which ultimately hurt creditors.
Last week, there was sheer turmoil at the banks. The American Silicon Valley Bank became insolvent and Credit Suisse was taken over by USB over the weekend. The latter was rescued from bankruptcy as a „too big to fail“ bank by both the Swiss government and a private competitor of the bank. The financial system is global. A crisis in California can cause wildfires thousands of miles away.
Central banks seem willing to sacrifice private banks and global financial stability to continue raising interest rates, curbing demand, disciplining workers and reducing incomes. Ann Pettifor writes that they preferred class struggle to financial stability. Indeed, if central banks are understood as instruments of class power, a logic emerges with their policy of tightening: if the long-term trend is declining productivity and profitability, and firms are engaged in cutthroat competition to increase their market share in a shrinking market environment, while at the same time there is potential for strengthening the working class, then triggering a recession in which it is difficult to impose wage increases is a specifically political way to intervene in this conflict. However, financial capital is the hegemon of today’s transnational class, so weakening it inevitably reduces the power of capital.
What happened. Last week, Silicon Valley Bank, the sixteenth largest banking institution with intense ties to tech companies in the U.S., became insolvent and was shut down by U.S. regulators. Inflation drives up (and reverses) interest rates, which in turn reduces the market value of bank assets like bonds. So the problem is that the market valuation of assets and mortgages has fallen as interest rates have risen. Interest rates on bonds and mortgages purchased several years ago are now much lower than those on new mortgages and new Treasury notes and bonds. When interest rates rise, the prices of these „old securities“ fall to bring their yield to new buyers in line with the Fed’s rising rates. When interest rates rise and bond prices fall, stock prices usually follow. However, if banks simply hold on to their bonds or mortgage packages, they do not have to devalue the market price of their assets accordingly. They only have to disclose the loss in market value if depositors pull their money out and the bank actually has to sell those assets to raise the money to pay off its depositors. Because SVB’s many corporate clients were not covered by deposit insurance and feared regulatory intervention, money was withdrawn and redeployed from this solvent bank. The growing gap between what investors could earn by buying risk-free Treasury securities and the small amount of money banks paid their depositors caused wealthier depositors to withdraw their money to seek higher market returns elsewhere. Most investors knew that higher interest rates would lower the price of bonds – most severely for bonds with long maturities. Asset managers avoided such price declines by shifting their money into short-term Treasury bills or money market funds while prices for real estate, bonds, and stocks fell.
To reiterate: When central banks raise interest rates, new government and corporate bonds are issued at higher rates. These higher interest rates increase the yield on the newly issued bonds. The yields on these bonds are higher the fewer new bonds that come to market. The new, higher-rated bonds are then more profitable for investors than the many bonds issued under lower interest rates. As a result, older bonds are sold as savvy investors pounce on the higher yields of the scarcer, newer bonds. The result of this price shift is that the prices of low-yield bonds fall.
However, this does not matter if the bonds are held to maturity and there is no pressure to sell. Over time, future interest rates may fall and bond prices may rise. However, if bonds have been used as collateral, lenders will find that the borrower’s collateral has lost value and will demand more collateral to support the (often large) outstanding debt. A scramble then ensues to sell or mobilize more capital to satisfy creditors.
Smaller U.S. banks in particular also experience losses that run into the billions of dollars on bonds in their portfolios. After the 2008 financial crisis, U.S. regulators had ordered banks to hold more government bonds, i.e. liquid assets, in their portfolios, the prices of which have now fallen as a result of Fed increases in key interest rates and are now partly responsible for (as yet unrealized) losses on banks‘ balance sheets. In China, too, the small banks are in danger and some are already on the verge of collapse. In China, this is again due to funding shortages in competition for deposits with larger banks and high defaults by local borrowers due to China’s economic slowdown in recent years. Credit Suisse is also slumping. Share prices of crisis-hit Credit Suisse plunged double digits last week. In its wake, bank shares are plummeting across Europe. Five-year credit default swaps (CDS) for debt securities consequently shot up to 574 basis points.
The question preoccupying the markets at the start of 2023 is what will happen if central banks continue to raise interest rates in response to the rise in inflation and continue to sell government bonds. The risk is not that government bonds suddenly become worthless because the U.S. government defaults or hyperinflation occurs, but more importantly that financial markets stop functioning as prices and yields become abnormal and trillions of dollars are shuffled around in portfolios, potentially triggering a crisis as hedge funds, banks and other investors now compete for cash.
translated by deepl.