Exactly 23 years ago it burst the first speculative bubble of the digital economy. Just then I was going to live in San Francisco, to talk about what we called the New Economy at the time. The The Nasdaq crash came fast and hard in March 2000, the tech stock market panicked after years of excessive rallying. Euphoria and crashes, bubbles and crashes, boom-and-bust, are in the DNA of Silicon Valley. The cradle of technological revolutions embodies the vision of capitalism defined by the Austrian economist Joseph Schumpeter: «Creative Destruction». Innovation sprouts on the rubble of failures.
The post-pandemic backlash
In the current crisis, another ingredient of Silicon Valley is added: the youthfulness. Big Tech is in the hands of twenty-somethings. Convinced that historical memory is useless. “This time it’s different”: the world begins with them. They did not see the inevitable backlash with a return to normalcy coming after the pandemic in which we were slaves to digital platforms and inflated their profits. Even fewer saw what it is coming a classic, very traditional banking crisis. Here historical memory helps. When inflation rises again – a phenomenon experienced by the parents or grandparents of start-uppers – central banks must raise interest rates to combat it. Goodbye to the money that cost nothing and helped finance the daring projects of start-ups with venture capital. With rates that rise, something else happens automatically: the old fixed-income securities that yielded little lose value because new securities with higher yields arrive on the market. We don’t need an algorithm here, it’s eighth grade algebra. The relentless rule also applies to safe investments, US Treasury bills.
The assault on the branches
Silicon Valley Bank had a clientele of tech start-ups and it is unbalanced to give him credit. When Big Tech crashed, some of his investments went down the drain. But other investments were safe. Unlike Lehman in 2008, Silicon Valley Bank did not invest in “toxic finance”, suspicious contraptions. She had a belly full of Treasury bills. But a Treasury Bond issued years ago when yields were 1 percent is worth less today as the US Treasury itself pays much higher interest. If a bank lives in a calm situation, it can wait for the bonds to reach their natural maturity, and the Treasury will reimburse them at their official value. If it is forced to sell them in advance to raise cash, it loses. Here you are the trivial mechanism of this crisis. First, word spreads among Silicon Valley Bank’s customers that the institution is in trouble. Everyone rushes to empty checking accounts. But no bank holds enough liquidity to be able to face a “run on the branches”. He has to sell stocks and it makes matters worse as he takes losses. Wall Street’s big banks should be more robust because they are subject to stricter reserve requirements, a result of the 2008 crisis. The fear of contagion affects medium-sized banks, such as Silicon Valley Bank which used to be the 16th in the country. Others have the same problem, they are sitting on a mountain of securities that may be “good” but devalued.
Biden’s intervention
The intervention of Joe Biden, Treasury Secretary Janet Yellen, Federal Reserve Chairman Jerome Powell, was swift and robust because they perceived the risk of contagion. Even if other banks fail, the Fed has unlimited firepower to restore calm. Each central bank is a “lender of last resort” with the duty to guarantee the stability of the credit system. The American one has one more prerogative: it can print dollars without limits since this currency has an “imperial” status, it is universally accepted. But to devote himself to the stability of the banking system the Fed may be forced into a break in its other mission, fighting inflation. Markets expect Powell to postpone the next interest rate hike as he waits for this storm to abate.
The political controversies
There will be political controversies. The left accuses Donald Trump of having relaxed some prudential rules passed in 2008, exempting precisely those medium-small banks that are now in the eye of the storm. The right accuses Biden of bailing out all Silicon Valley Bank customers at taxpayer expense, even the very wealthy (with deposits well in excess of the $250,000 insured limit). The suspicion of preferential treatment is linked to the fact that the Big Tech world of the West Coast is left-wing, finances the Democratic party, promotes the culture of political correctness. There is the geopolitical backdrop. In the 2008 crisis, the Chinese Communist Party leadership became convinced that American capitalism was terminally ill. Xi Jinping then began his rise to power, under the banner of a socialist, statist and dirigiste restoration. Today Xi is at the rescue: he “signs” the thaw between Iran and Arabia, tries to present himself as a mediator even in Ukraine. Every sign of trouble in the American system is a plus for Beijing.