In March 2023, three banks Silvergate, Signature NY, and Silicon Valley Bank (SVB) closed consecutively in a span of a few days. In the case of SVB, their clients decided to withdraw their money all at the same time, aided by the speed of online banking. This against the backdrop of the Fed raising rates nonstop since mid 2022 and tightening by no longer buying bonds and mortgage backed securities in order to fight inflation.
At the same time, the housing market is in dire straits. Many buyers are balking at high mortgage interest rates, and sellers can’t get the price they want. Housing starts are also lower as a result of the lack of interest in starting new construction. Office space in some cities may no longer recover as many employees prefer to work from home and many remain empty.
How did we get to this situation. A few years ago, most central banks were at near zero interest rates. Creating inflation was actually a problem. Money was cheap, labor was cheap, energy was cheap, supply chains were efficient, and so GDP kept growing on the back of those factors.
The pandemic threw a monkey wrench on all that. For more than two years, we were all limited in our activities. We could work from home. Fortunately videoconferencing techniques like Zoom and Google Meet were there to somewhat give us some semblance of work capability. But it is only now that we are starting to move around and do most of the things we took for granted pre-pandemic.
Although economies globally have started to open up, with China as the latest to try to attempt to do so, the problem is the excess liquidity in the market. The CARES Act of 2020 pumped in $2.2T into the hands of ordinary citizens. As a result, the M2, the US money supply, grew to $26.2T against a backdrop of a $31.6T national debt.
This is a global phenomenon. There’s too much money in most places that got released during the pandemic. Most central banks globally have now raised interest rates from near zero to an average that nears five percent at the moment. For the US, this is the overnight lending rate to banks. This means that the bank rates for home mortgages, car loans, and other types of loans are higher because banks need to add their own profit to the Fed rate. Many Americans have depleted their savings and are living on credit. With the higher rates, they have either decided to not spend or at least cut discretionary spending. Thus non-essentials like tech products such as iPhones and new Teslas are expected to have lower sales.
In recent years, an economic hypothesis called Modern Monetary Theory (MMT) sprung up. This seemed to be the magic pill that big government advocates wanted to fund their wars, their pandemic relief, their social programs, and other big expenditures without the benefit of actual government revenue.
MMT basically argues that government can print fiat currency and spend it without too much regard for what is collected from taxes and the size of the national debt. The only restriction is that the spending should create jobs and productivity, and fiscal restraint should not matter much. That’s pretty much like giving your children credit cards and telling them to spend to their heart’s content no matter if the credit limit has been surpassed. Senator Bernie Sanders, and Congresswoman Alexandria Ocasio-Cortez are big fans of MMT.
Normally what you want is a situation where your debt does not far outpace your GDP, your productivity, so that the debt to GDP ratio is manageable. Government gets revenue from taxes to fund spending. With MMT, that has not been the case. MMT advocates just went ahead and printed all the money they want. The result is runaway inflation, to which the Fed now has to resort to increased interest rates and tightening of its massive holdings.
With all the surplus of dollars that came out because of MMT, we now have high inflation. Foreign governments who buy our bonds now wonder why our global reserve currency can’t even seem to pay off its own huge debt. There are other concerns of course that impact this, like the weaponization of the dollar to sanction against countries that don’t toe the line on what we want them to do. But the large quantity of dollars shown by our M2 supply to pay for unchecked spending left and right is a large part of the problem.
We need to get back to responsible fiscal spending. MMT is not and was never the right way forward.