An esteemed professor and economist pointed out that persistent inflation, the impending economic recession and an imminent insolvency crisis in the banking sector is leading the U.S. into a “doom loop.”
Nouriel Roubini, an erstwhile economic advisor to the Clinton administration, outlined his findings in a March 30 commentary titled “The Coming Doom Loop.” His piece published on Project Syndicate noted that to solve the decade-high inflation and provide liquidity support, “the only solution is a severe recession – and thus a broader debt crisis.”
“A severe recession is the only thing that can temper price and wage inflation, but it will make the debt crisis more severe, and that in turn will feed back into an even deeper economic downturn,” wrote Roubini. Given that throwing more money into the economy will not prevent this “systemic doom loop,” he urged everyone to prepare for the upcoming “stag-flationary debt crisis.”
Moreover, the economist blamed the “current regulatory regime” allowing banks to treat securities and loans “at their face value rather than their true market value” for the impending collapse of the banking system. He noted that most U.S. banks are technically near insolvency, and that hundreds more are already fully insolvent. (Related: The death of the Dollar is coming sooner than expected – when it happens expect bank runs and closures, food scarcity, riots, high unemployment, and hyper-inflation.)
Roubini also discussed the “duration risk” principle in his March 30 commentary. Under this principle, higher inflation leads to “higher bond yields, which in turn would hurt stocks as the discount factor for dividends rose.” At the same time, “higher yields on ‘safe’ bonds would imply a fall in their price” – owing to the inverse relationship between yields and bond prices.
“This basic principle seems to have been lost on many bankers, fixed-income investors and bank regulators,” he lamented.
Inflation, rate hikes hit banks hard
“Making matters worse, higher interest rates have reduced the market value of banks’ other assets as well,” Roubini continued.
“If you make a 10-year bank loan when long-term interest rates are one percent and those rates then rise to 3.5 percent, the true value of that loan – what someone else in the market would pay you for it – will fall. Accounting for this implies that U.S. banks’ unrealized losses actually amount to $1.75 trillion, or 80 percent of their capital.”
The economist ultimately concluded that central banks cannot “fool” themselves any longer by continuing to believe that rate hikes could curb inflation – while using liquidity support to maintain financial stability at the same time.
The collapse of Silicon Valley Bank (SVB), Signature Bank and others caused depositors to become jittery. An initial surge of $129.3 billion in deposit outflows from all U.S. domestically chartered banks was recorded in the first week following SVB’s failure. This has since slowed down to $84 billion.
U.S. regulators believe that while the surge in withdrawals represents a stabilization in deposit outflows, there remains considerable uncertainty as to where things will go moving forward.
“What’s unclear for us is how much of these banking stresses are leading to a widespread credit crunch. That credit crunch … would then slow down the economy,” said Federal Reserve Bank of Minneapolis President Neel Kashkari. “This is something we are monitoring very, very closely”
Mohamed El-Erian, another noted economist, also pointed out that ongoing deposit outflow from regional banks definitely spells trouble. He warned: “This could become a big issue for local communities, regions and sectors that fear that their access to loans will be curtailed because their traditional banking partners will have to shrink their balance sheets after losing deposits.”