America's Only Two Financial Paths Moving Forward

Over the past two weeks banking volatility has soared due to bank failures caused by raising rates. As I highlighted in my last newsletter, Silicon Valley Bank: The Safest Place to Keep Your Money - As of Monday | The Hill Meets Households (beehiiv.com), the government has created a defacto nationalized banking system where banks can make bad decisions/investments and the government will come and bail them out (with taxpayer money). This economic climate mixed with a spend heavy government has created a tough looming situation for Americans. As its shaping out now, there are two different scenarios or paths that will get us out of the economic crisis we are in. Neither are good.

Path 1 - Hyperinflation

The first, and easily most destructive path is hyperinflation. For those of you who don’t know what hyperinflation is, here is a screen shot from Investopedia:

Said differently, hyperinflation occurs when price increases get out of control. What we experienced over the past year was high inflation but nowhere close to hyperinflation.

How will this economic crisis lead to hyperinflation?

Since the government is working as a back stop for banks in case they default, banks will be less likely to change bad habits and self-correct themselves to prevent events like the SVB collapse from happening again. Don’t believe me? In 2008, the exact same type of collapse happened to major financial institutions as they made poor risky investments without being able to read the financial terrain in front of them. Not learning from the mistakes of the past, SVB defaulted on bonds and mortgage-backed securities (same as 2008) without being able to read the financial terrain in front of them (raising interest rates).

Banks and financial institutions aren’t the only ones less likely to change bad habits. Customers (depositors), when placing their money in a bank, are supposed to do some sort of due diligence. A government back stop makes depositors less inclined to do their research on banks if they know that their money is guaranteed regardless.

What this means is banks and financial institutions will continue to make bad investments, give out bad loans, and do risker things because they are “backed” by the government. This will lead to more bank defaults, more financial institution failures, and more bailouts. More bailouts means more money the government is spending. The government doesn’t have the money to keep bailing out financial institutions, so it will continue to print money to meet its demand. Over time, this process will snowball into the government printing trillions of dollars to be a financial backstop of all Americans, all business, and all financial institutions. Those trillions will cause hyperinflation.

Outcome of hyperinflation

Hyperinflation is a country killer. It completely destroys the currency of the country and a lot of the value in it. This is the least likely of the two scenarios to happen.

Path 2 - A Massive 1930s Style Recession

In the 1930s the biggest recession in American history hit, causing massive economic and financial damage. Here are a few key statistics from the 1930s “Great Recession”:

• GDP decreased by 33 %

• Industrial production fell by 47 %.

• 1/5th of banks failed

• Unemployment increased to 25 %

• Wages fell by 42 %

• Consumer Price Inflation (CPI) fell by 27 %

These are absolutely mind-boggling numbers but help to show the severity of the recession.

How will this economic crisis lead to a massive recession?

In order to prevent inflation (eventually hyperinflation), the Fed will need to continue to raise interest rates to dry up the money supply. Drying up the money supply basically means the Fed limiting the amount of money in circulation. This is really the only tool the Fed has to correct inflation. However, when you dry up the money supply, interest rates rise since money is now scarce. The rising of interest rates will cause poorly invested companies and financial institutions to default and fail (for a lot of different reasons). This will result in layoffs and slower economic growth for the overall economy. Since inflation is still high at 6% year over year, the Fed has a long way to go and a lot more interest rate hikes to implement. The SVB collapse was only the start of potential collapses. Below is a New York Post article about a study that found two hundred at risk banks.

This is only the beginning of failing institutions and will continue to get worse as the government spends more money it doesn’t have. I don’t see a realistic third way out of this and certainly not one that will result in a “soft landing”, but I am open to any and all opinions. Feel free to comment on twitter or emails us with any thoughts or questions.

What to do to prepare.

In my next newsletter I will highlight some ideas and ways to be prepared for what is coming next.

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