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OPINION AND ANALYSIS | 18-03-2023 03:12

Panic in Silicon Valley

The global economy has stepped on another landmine. Increased instability will hurt Argentina, as it did after 2008.

The global economy has stepped on another landmine with the implosion of Silicon Valley Bank and the ensuing financial turmoil that is nowhere near done. While experts agree that the situation is completely different from 2007 (when the US housing bubble began to burst causing a global financial crisis), contagion has pushed large and systemically important banks against the ropes, like Credit Suisse, and this time around the world’s largest central banks, starting with the US Federal Reserve and the European Central Bank, must try and stave off a financial crisis in the context of high inflation, meaning they were in the middle of tightening financial conditions. Argentina, generally locked out of international markets and with strict capital controls that limit the flow of money, can escape some painful short-term effects, and maybe even benefit from a potentially lower rate environment, but the long-term pain will be felt if this spreads, just as happened in the aftermath of the global financial crisis.

Bank runs, fear and bailouts are all words we got used to during the 2007-2008 implosion of the US economy, followed by the European financial crisis of 2010. While there are certain similarities, the situation today is different. During the build-up to the subprime crisis regulation had been regularly relaxed to allow banks to take on more risk, financial institutions took on incredibly lax levels of leverage, and greed led to the massive proliferation of toxic real-estate loans masked behind complex financial structures (remember collateralised debt obligations or CDOs?) that gave the illusion of safety. The system as a whole failed and the collapses of Bear Stearns and Lehman Brothers quickly rippled through the United States and then the global economy. The Fed and the US Treasury went on a bailout rampage, massively injecting capital into the system — especially through quantitative easing or QE, which is money printing alla Americana — a situation that was replicated two years later by the ECB when the PIIGS (Portugal, Ireland, Italy, Greece, Spain) began to wobble. Ultimately, Fed Chairman Ben Bernanke and his European counterpart Mario Draghi were seen as heroes who managed to navigate the worst crisis since the Great Depression moderately well. Interest rates were taken to the zero bound and beyond while tighter regulation forced banks to bulk up their balance sheets.

For Argentina, the global financial crisis meant the end of the first phase of Kirchnerism, marked by fiscal and trading surpluses fuelled by a commodities super-cycle on the back of Chinese demand. Néstor moved into the background and Cristina Fernández de Kirchner took charge. With Amado Boudou and Axel Kicillof as her most important economy ministers, the then-president’s response to the changing and more challenging global environment was to maintain the populist spending of her husband and to raid every possible state coffer to pay for it. As she leaned more authoritarian, and dollars ran out, she imposed capital controls and faked official statistics to cover up incipient inflation. As the situation gradually worsened, levels of division in society grew. It was a prelude to what was to come and part of the reason why we are where we are today.

More than a decade of ultra-loose monetary policy has disrupted incentives throughout the global economy. The rise of Silicon Valley was turbo-charged, with unicorns springing up left and right trying to outspend each other as raising capital was a joke. Big Tech hired en masse, paying huge salaries as they competed for talent. Equities reached record-highs even as the Covid-19 pandemic, wreaked havoc in the face of shutdowns and a painful global slowdown. As we came out of the pandemic inflation began to take hold as supply-chain bottlenecks faced off with pent-up demand in a world flush with Covid stimulus money. Russia’s invasion of Ukraine caused a shock increase to energy prices which hurt Europe in particular. And finally, faced with inflation unbeknownst in decades, major central banks mustered the courage to raise interest rates. The intention was to slow down price increases by cooling the economy, with Fed Chair Jerome Powell being explicit in that it would cause pain and higher unemployment. Argentina remained locked out of international markets and with firm capital controls in place. Despite a historic opportunity due to the attractiveness of our exports, the chronic lack of dollars means inflation has topped 100 percent annually while the incapacity to pay for imports is forcing an economic slowdown. Bailed out by the International Monetary Fund, the country is deeply indebted both externally and internally, as a snowball of peso-denominated bonds raises systemic risk.

Silicon Valley Bank’s implosion and the successive bailout of its depositors were caused by poor risk management as it got trapped in longer-term bond holdings as the Fed rose rates. This meant that unrealised losses were mounting as its lower-interest rate holdings lost value vis-à-vis newer bonds with higher yield. A standard bank run was the coup de grace, as fear spread through the system and finally sentenced SVB. Known for its work with start-ups, venture capitalists, and the crypto sector, it rippled through the financial system, knocking First Republic Bank and even Credit Suisse, both of which were rescued. This crisis has hit at the heart of one of the most dynamic sectors of the US economy, the tech sector, and also dealt a hard blow to the crypto sector which had seen two other major banks fall in the week before SVB: Signature Bank and Silvergate.

The US financial sector does appear capable of absorbing the shock, particularly as the largest banks have effectively become too big to fail. Not only do they count with an implicit guarantee from the government, they are subject to more stringent regulation and are in relatively strong shape. It was smaller banks that were excluded and are at risk. Beyond the United States, the fall of Credit Suisse could indicate a weaker situation in Europe. It isn’t clear whether these collapses will stay in the Fed’s mind when it comes to its fight against inflation, but this new ecosystem of higher rates is irreversible and its impacts will continue to reverberate through the global economy. This increased instability will also hurt Argentina, as it did after 2008. Lower demand for our goods and services will mean less hard currency for the cash-strapped Central Bank. Higher interest rates and fear means risk aversion and therefore lower investments in places like Vaca Muerta or the lithium fields of the north. The few Argentine companies that have access to credit will see it squeezed even further.

It remains to be seen whether the Fed, the ECB and other policy makers will be able to transmit this new paradigm in a manner that they avoid unexpected potentially systemic events like SVB’s meltdown. History suggests there’s more to come. Whether that’s enough to cause a full-blown global crisis hasn’t been ruled out yet.

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Agustino Fontevecchia

Agustino Fontevecchia

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