Rolling the Dice

The approaching endgame for the U.S. economy

Issues discussed:

• U.S. banks have been selling their assets and emptying their reverse repo balances to pay for the outflow of deposits.

• The federal government has, most likely, tapped into the same source of ‘excess money’ to feed its massive deficit.

• This stock of excess money is now being depleted, rapidly, and the Biden administration seems to have decided to ‘roll the dice’ on the U.S. economy.

In this entry, I first continue to map the situation in the U.S. banking sector and then dwell into the source of the funding for the current massive fiscal deficit run by the U.S. federal government. It turns out that both banks and the U.S. government have been likely to tap into the same source of “excess funds” to finance their deficits. This creates yet another potential (major) shock, which can hit the U.S. economy during H1.

On Wednesday, we published a Deprcon Outlook Special Issue, where we simulated the plausible loan losses for U.S. banks using three scenarios: 1) a ‘soft-landing’, 2) a financial crisis, and 3) a repetition of the Great Depression. Unsurprisingly, loan losses differ rather drastically between the scenarios. Especially the repetition of the Great Depression yielded almost a total devastation of the U.S. banking sector. This is also why it’s mostly theoretical, establishing the worst-case scenario for loan losses.

However, what is worrying about the Great Depression -scenario, is that the rates of loan delinquencies (defaults) while large, were not completely out-of-this-world. If the U.S. would face a nationwide bank run, it could push the economy into a credit depression, which could lead to something resembling the Great Depression of the 1930s. Authorities would naturally do their utmost to stop such a drastic development, but the question is, will they have the funds for it, when the crisis hits? That turns out to be a big “if”.

Creating instability

Like I have been detailing (see, e.g., this), the roots of the banking crisis, which first wave hit in March, lay on the detrimental decisions of authorities. They forced banks to obtain and hold U.S. Treasuries and encouraged banks to provide loans to corporations and consumers under stress due to the lockdowns. These created the banking crisis, which is now just on pause.