In fact, there is always a trade-off between monetary stability and financial stability – but that trade-off is particularly acute when inflation is in the high single digits and financial institutions are disappearing at weekends.
Central bankers have convinced themselves they can take a targeted ‘macro-prudential’ approach. They believe their inflation and financial stability objectives are distinct, and addressable with different tools. Rate hikes to fight inflation. And liquidity provisions to preserve banking stability. But sooner or later all these support packages begin to look like QE.
Since May 2022, the US banking system has lost $700 billion of deposits – a large portion of which followed the dramatic implosion of Silicon Valley Bank last month.1 The money multiplier means the true impact is greater. Investors now worry about the return of their investment rather than the return on their investment.
This mini-banking crisis has caused a sudden tightening in credit availability and lending criteria. This will hit the real economy. Regional banks are the primary source of credit for small and medium-sized businesses and commercial real estate.
To offset this tightening, the Fed has sluiced the system with ‘temporary’ liquidity, unwinding more than half of last year’s quantitative tightening. They did this with a new acronym called the BTFP (bank term funding program). One observer suggested this stands for “buy the flipping pivot!” Unless we misheard.
The apparent free will of central bankers is proving illusory. Ultimately, their primary goal of controlling inflation takes a back seat when it begins to threaten the stability of the financial system. Higher inflation is the least painful option when the alternatives, in extremis, could echo the 2008 financial crisis or the even Great Depression. But first the man on the street needs to feel enough pain to beg for the mercy of the monetary firehose. We are getting closer to that point. Time to seek shelter from the storm.
