May 9, 2023 - 1:00pm
As a slew of banks wither from the Federal Reserve’s tight money policies, the noose is finally tightening in credit markets. Monetary policy impacts the economy in two ways. First, it makes the cost of credit — the interest rate — more expensive, which discourages borrowing. Secondly, it puts stress on the financial system that results in banks becoming less and less willing to lend people money as they fear that borrowers might default.
We are now seeing a very sharp tightening in credit markets. Loans for everything from small firms and consumer credit to the automotive and construction industries are becoming harder to get hold of. Outside a very brief period at the start of the pandemic, we have not seen credit tightening like this since the 2008 financial crisis.
Economists often refer to the “credit cycle”. At the start of the cycle banks are confident and flush with money, and interest rates are low. Banks start to lend and people start to borrow. At a certain point, however, excesses creep in. Less trustworthy borrowers get access to credit. Then the central bank starts to raise rates and credit standards start to tighten up, with banks becoming increasingly conservative with their lending. Finally, the cycle breaks, lending collapses, the economy falls into recession and the bad loans start to default.
We are currently somewhere near the top of the tightening part of the cycle. The wave of defaults has yet to take place, but there is every reason to think that the dam could break at any moment. Borrowers are starting to sense this and demand for loans is drying up. In the market for loans, fewer people are buying and fewer people are selling. Meanwhile, every time a bank blows its lid other institutions get increasingly nervous.
When does it all come crashing down? On this, the markets are divided. Many institutions are now positioning themselves for a recession, assuming as they do that when banks blow up one is just around the corner. Hedge funds, though, are betting against such an outcome. They think that the economy remains too strong, despite the tightening credit standards. Yet neither banks nor hedge funds have any illusions about what the result of all this is.
The big question is whether the economy will recover from this recession. After 2008-09, stagnation set in, with central banks having to print large quantities of money to try to lift the economy from its slumber. This time around, we are going into a recession with serious structural inflationary problems, not to mention a nascent trade war between the world’s two largest economies (China and the United States). If the post-2008 recovery was sluggish, the comeback from the approaching recession might be even more challenging.
Philip Pilkington is a macroeconomist and investment professional, and the author of The Reformation in Economics
philippilk
Join the discussion
Join like minded readers that support our journalism by becoming a paid subscriber
To join the discussion in the comments, become a paid subscriber.
Join like minded readers that support our journalism, read unlimited articles and enjoy other subscriber-only benefits.
SubscribeAn excellent summary of our current situation, imo. I don’t know why Unherd doesn’t give Mr. Pilkington the opportunity to write a full-length article. I’d rather read about the economy (any suggestions for a way out of our current mess, Mr. Pilkington?) than how yoga became feminized.
Agreed. As a long-time male yogi myself that article and its tee-hee tone was particularly irritating. Yoga is a very hetero zone, unlike gyms bursting with gay men (here in Miami anyway) whose over-developed musculature means they can barely walk straight. Sorry to be off topic but thanks for the excuse!
Agreed. As a long-time male yogi myself that article and its tee-hee tone was particularly irritating. Yoga is a very hetero zone, unlike gyms bursting with gay men (here in Miami anyway) whose over-developed musculature means they can barely walk straight. Sorry to be off topic but thanks for the excuse!
An excellent summary of our current situation, imo. I don’t know why Unherd doesn’t give Mr. Pilkington the opportunity to write a full-length article. I’d rather read about the economy (any suggestions for a way out of our current mess, Mr. Pilkington?) than how yoga became feminized.
Let’s not forget the part where raising interest rates instantly devalues treasury bonds and obliterates shareholder equity. Banks park money in “safe” treasury bonds that are issued at market interest rates – but when the central bank raises rates, the existing bonds lose value. Silicon Valley Bank was holding $91 billion worth of treasuries before rates went up – they were quickly devalued to $76 billion and that wiped out all their equity and started the run on deposits. These banks didn’t blow themselves up – they are being brought down by rate hikes, made necessary by inflation, caused by out of control government borrowing and money printing. If they made mistakes, it was perhaps listening to the central bankers and politicians and media who smugly denied inflation could be caused by money printing, then denied that inflation was happening.
I thought inflation was caused by COVID-induced supply chain shortages?
Inflation is always caused by an increase in the money supply. The supply chain shortage merely accelerated the trend that was already put in motion by Covid-induced biblical money printing.
Inflation is always caused by an increase in the money supply. The supply chain shortage merely accelerated the trend that was already put in motion by Covid-induced biblical money printing.
Both the banks and the executives were too young in those cases. None of those banks were around 40 years ago, the last time we had serious inflation, so they have no institutional memory of how to handle it.
Bank deposits are short term liabilities, subject to withdrawal at any time. Long term treasury bonds are, well, long term assets. It was the mismatch in maturity that brought those banks down, not the Fed rate hikes. It was incredibly irresponsible for those banks to invest the way they did. Well managed banks don’t invest billions in fast-money deposits in 30 year MBS or Treasury bonds at rock bottom interest rates. Anyone at all familiar with bond math understands this. The bank’s management certainly did.
I thought inflation was caused by COVID-induced supply chain shortages?
Both the banks and the executives were too young in those cases. None of those banks were around 40 years ago, the last time we had serious inflation, so they have no institutional memory of how to handle it.
Bank deposits are short term liabilities, subject to withdrawal at any time. Long term treasury bonds are, well, long term assets. It was the mismatch in maturity that brought those banks down, not the Fed rate hikes. It was incredibly irresponsible for those banks to invest the way they did. Well managed banks don’t invest billions in fast-money deposits in 30 year MBS or Treasury bonds at rock bottom interest rates. Anyone at all familiar with bond math understands this. The bank’s management certainly did.
Let’s not forget the part where raising interest rates instantly devalues treasury bonds and obliterates shareholder equity. Banks park money in “safe” treasury bonds that are issued at market interest rates – but when the central bank raises rates, the existing bonds lose value. Silicon Valley Bank was holding $91 billion worth of treasuries before rates went up – they were quickly devalued to $76 billion and that wiped out all their equity and started the run on deposits. These banks didn’t blow themselves up – they are being brought down by rate hikes, made necessary by inflation, caused by out of control government borrowing and money printing. If they made mistakes, it was perhaps listening to the central bankers and politicians and media who smugly denied inflation could be caused by money printing, then denied that inflation was happening.
I’m sure that our valiant crew at the Fed is readying the printing machine and quantitative easing gizmo to flood the economy with money to stop the mess. The housing market will collapse making for a windfall in the affordable housing crowd. And, as the currency becomes worth less and less we can take care of the reparations whine with a printing of $ Trillion notes to be distributed according to color, gender, sex, species or whatever. What a wonderful world.
My worry is they are casting about for the next war to get rolling too, as that is one of their main go-to’s.
My worry is they are casting about for the next war to get rolling too, as that is one of their main go-to’s.
I’m sure that our valiant crew at the Fed is readying the printing machine and quantitative easing gizmo to flood the economy with money to stop the mess. The housing market will collapse making for a windfall in the affordable housing crowd. And, as the currency becomes worth less and less we can take care of the reparations whine with a printing of $ Trillion notes to be distributed according to color, gender, sex, species or whatever. What a wonderful world.
I predict an as yet ignored cause/effect trigger to the crisis. The collapse of Warren Buffet’s Berkshire Hathaway empire due to their massive over exposure to the non-life reinsurance sector, coupled with the sectors stone age inability to embrace electronic trading, securitisation and hedging derivatives, and being run by monopoly brokers with very low levels of qualification, sophistication and financial training. The US , Bermudan and London markets in this industry are in a denial that makes pre Lehman 2008 look positive genius! … watch this space…
I predict an as yet ignored cause/effect trigger to the crisis. The collapse of Warren Buffet’s Berkshire Hathaway empire due to their massive over exposure to the non-life reinsurance sector, coupled with the sectors stone age inability to embrace electronic trading, securitisation and hedging derivatives, and being run by monopoly brokers with very low levels of qualification, sophistication and financial training. The US , Bermudan and London markets in this industry are in a denial that makes pre Lehman 2008 look positive genius! … watch this space…
The trigger to look for is a sudden acceleration in unemployment rising while at the same time the huge numbers of vacancies in western economies start to rapidly decline. Also a tailing off of rising wages across the board.
Chat GPT 5 can do 80% of Western Jobs according to some highly credentialed guy I never heard of before, but he sounded right.
All is needed is the interface between the customer and the business that Chat fills. Just that – spoken, written, Doctor, Lawyer, newsman, insurance seller, really – everything, because Chat can do your job better than you can.
I think there is your surge in unemployment lurking. I am buying gold, vegetable seeds, and canned foods…..trying to figure how to tie a butcher knife on the end of a stick for defense…. it will get rough….
“…I am buying gold, vegetable seeds, and canned foods…”
At your local variety store I assume. Better get some fork handles while you are there, just in case. And don’t forget the barbecue spice-mix with that – the flavour of the gold doesn’t come through without that.
can ChatGPT unclog my toilet?
The jobs that will survive,maybe their scarceness and competition for them will raise the status of them when top category people are going for them. Maybe we’ll get a slew of books or even movies about how I was an investment banker then a bot took my job so I became a janitor and now I run a company supplying janitors,and they’ve all got degrees.
The jobs that will survive,maybe their scarceness and competition for them will raise the status of them when top category people are going for them. Maybe we’ll get a slew of books or even movies about how I was an investment banker then a bot took my job so I became a janitor and now I run a company supplying janitors,and they’ve all got degrees.
“…I am buying gold, vegetable seeds, and canned foods…”
At your local variety store I assume. Better get some fork handles while you are there, just in case. And don’t forget the barbecue spice-mix with that – the flavour of the gold doesn’t come through without that.
can ChatGPT unclog my toilet?
Chat GPT 5 can do 80% of Western Jobs according to some highly credentialed guy I never heard of before, but he sounded right.
All is needed is the interface between the customer and the business that Chat fills. Just that – spoken, written, Doctor, Lawyer, newsman, insurance seller, really – everything, because Chat can do your job better than you can.
I think there is your surge in unemployment lurking. I am buying gold, vegetable seeds, and canned foods…..trying to figure how to tie a butcher knife on the end of a stick for defense…. it will get rough….
The trigger to look for is a sudden acceleration in unemployment rising while at the same time the huge numbers of vacancies in western economies start to rapidly decline. Also a tailing off of rising wages across the board.