Boom and bust cycles: Financial system lurches from crisis to crisis

The recent collapse of Silicon Valley Bank and the crisis at Credit Suisse – which saw a government-initiated merger between it and UBS bank – as well as the prospects of other banks failing internationally is nothing new.

The events are part of the regular cycle of “boom and bust” within the global financial system and have graphically illustrated the systemic vulnerabilities that regularly develop into crises.

It may seem as though these events are occurring due to the consequences of new, different or riskier methodologies or processes being applied in international banking and finance. Similarly, it may also seem as though the solutions being applied are new, different or innovative.

However, not only are all current financial and economic events related to the current crisis – whether consequences or (temporary) solutions, not new or different – they are instead old, predictable and regularly occurring.

They have been occurring, in ever-shortening cycles, for some centuries. Moreover, these cycles occur as a result of exactly the same root causes, carry the same consequences, and are (temporarily) stabilised via the same solutions. Only the terminologies to describe the various components of the events – and the names of victims or saviours – are new.

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Examination of the root causes of these regular crisis and cyclical corrections reveals exactly the same systemic pattern throughout: crisis cause – crisis effect – (temporary) crisis stabilisation – inter-crisis period – next crisis…

As examples, just as the model for the shoring up of the systemic liquidity shortfall affecting Silicon Valley Bank’s uninsured depositors saw the Federal Deposit Insurance Corporation (FDIC) utilise funds from what is now called the Temporary Liquidity Guarantee Programme, so, too, in the great financial crisis of 1914 a similar process – utilising the Aldrich-Vreeland Emergency Currency – was used to shore up the systemic liquidity shortfall.

This mechanism also played a role in the successful seizure of global financial hegemony away from Great Britain and transfer thereof to the US, which effectively transformed the US financial system – with its inherent structural strengths and its inherent structural weaknesses – from a US-based one to a global one.

Similarly, in the 1933 financial crisis, the process to shore up institutions affected by systemic liquidity shortfall was the Federal Reserve Currency (a nondigital earlier version of the currently-proposed CBDC, Central Bank Digital Currency). At that time, certain rules and regulations relating to noninsured deposits were waived and all deposits were safeguarded… much the same as happened in the Silicon Valley Bank and Credit Suisse crises.

Other examples of state intervention occurred during the great financial crisis of 1907, when the Sherman Antitrust Act (anti-monopoly) rules and regulations were set aside to enable US Steel to acquire the Tennessee Coal, Iron and Railroad Company, to stabilise an otherwise at-risk large brokerage firm (Moore & Schley).

Anti-monopoly rules and regulations – as well as suspension of the requirement for shareholder votes of approval – recently occurred to enable UBS to acquire Credit Suisse.

While all the “exceptional” measures taken to “rectify” or “stabilise” a crisis situation are variations of the same measure – waiving of existing laws and regulations to create and inject huge amounts of additional credit into the market, or into the de facto insolvent entities – it is the regularly occurring systemic liquidity shortfall in the international financial system which is the root cause of all these crises.

The sources of these structural vulnerabilities include the proliferation of (ultimately) unsecured credit-based or speculation-based financial instruments and activities. These are exacerbated by the creation of, proliferation of and holding of derivative-based or future-based financial instruments of value, that result in (theoretically) very significant and impressive – but ultimately (and practically) unsecured – balance sheets that will fail a liquidity test during a period of cyclical correction.

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This repetitive system is perpetually vulnerable in the event of interest rate fluctuations, and other economic variables. When the international economic situation is in a state of periodic correction (as it currently is, due to the cyclical correction required to offset the credit generated to subsidise non-productive populations and companies during Covid), the stage is set for cyclical corrections (such as inflation) on a very significant scale – which will last for a sustained period.

An indicator of the potential severity of the current crisis is that there are currently many more banks that are potentially at risk – in the US and in Europe – that have uninsured deposits and low or negative liquidity ratios – the same as (or worse than) those of Silicon Valley Bank, Signature Bank or Credit Suisse.

The problem, of course, is when the waiving of existing laws and regulations to de facto flood the market with additional credit does not work. This occurs when systemic liquidity shortfall is just too high to bridge – as was the case with the 2008 financial crisis.

It remains to be seen if this will yet become the case with the current crisis.

Boom and bust cycles have only two to 10 years between events and, without some modification, this perpetual process of lurching from crisis to crisis will occur ad infinitum.

The question is, therefore, what to do to support the existing global financial system, in order to ameliorate its weaknesses and vulnerabilities. The primary consideration here is to initially support – not replace – the existing system; and thereafter, perhaps, to gradually replace it – but in a benign and cooperative manner.

The reason for this approach is that there are many aspects of the global financial system that work and that are robust (it is neither all bad nor all good), and furthermore, it exists and it functions, and to replace it in its entirety and precipitously would not just leave a void for a considerable period, it would also create chaos.

– Sterzel is chair of the global telephony company Webtel.mobi (Holdings) Limited.