The Great Simplification with Nate Hagens - A Bigger Boat | Frankly #26

Episode Date: March 16, 2023

In this Frankly, Nate shares some context about how he thinks about the recent global banking and financial market news. How do the catalysts triggering the SVB collapse compare to the 2008 financial crisis? What might world financial market reactions indicate as we move closer to The Great Simplification? What can we learn and proactively plan for by taking a balanced, comprehensive view of the global financial system and banking? One thing to be sure of: world governments and central banks "are gonna need bigger boats" as more and more entities require bailouts and guarantees. Eventually that 'boat' may become so big that it will be "Too Big to Save".   Watch on Youtube: https://youtu.be/eOYU1VlwTNs   For Show Notes and More: www.thegreatsimplification.com/frankly-original/26-a-bigger-boat 

Greetings. Finance again on the front pages. When I see what's happening this week with Silicon Valley Bank and Credit Suisse, the first thing that comes to mind is that scene from the movie Jaws where Chief Brody sees the size of the shark for the first time and tells the boat's captain, we're going to need a bigger boat. I'm going to unpack this on this week's frankly. Greetings. Oh boy. So last week's, week, I did a frankly called Loss Aversion. I record these on Tuesday or Wednesday for broadcast on Friday because Leslie and Lizzie put in some graphics and music and such. But with the way the world is going, I had no idea about Silicon Valley Bank or Credit Suisse or what was going on.

So loss aversion was perhaps relevant to many people and depositors paying attention. So here's the deal with this podcast and my work. This will never be a urgent commentary on what's going on now. So if you are a investor or a speculator, this information is probably not helpful. What I'm trying to do is look at the intermediate and long-term trends of society. I'm very confident of my worldview for the next five to seven years. I really have very little idea what's going to happen the next five to seven months, let alone the next five to seven days. But I think this biophysical phase shift where our society is starting to lose confidence

in the money and technology are going to solve all our problems and start to look a little bit closer, a little bit deeper as to what's really going on. and I will continue to comment on that. So I want to talk a little bit today about the banking situation, but let's take a big step back. So in the New Testament in the Bible, there was something called the Four Horsemen of the Apocalypse. They were conquest, war, famine, and death.

Then in the Old Testament, they were also four horsemen. they were sword, famine, wild beasts, and pestilence. I would argue, and this is why as much as I talk, as much as I care about climate change, biodiversity, and the natural world, that is what speaks loudest to my heart and my ethos. My intellect and my integrated assessment of our world suggests that those, Those aren't going to be the things that drive our decisions. So I would argue that the four horsemen of 2023 or the 2020s of human society are finance and the financial system, geopolitics and potentially war, complexity of the six continent overnight supply chain and the social contract, the social cohesion of our society. I think finance is what I'm going to talk about here, and this is complicated for a lot of people.

So let's start with banks. Banks really are leveraged bond funds. For the longest time, we had a positive sloped yield curve, which meant that long duration bonds, like seven years, 10 years, 30 years, had higher interest rates than short-term bonds or bills. And that's because people pay more for uncertainty and risk. Now, what happened with COVID and what happened to our entire world the last 20 years is every time we have a economic problem, we respond by throwing central bank created money and guarantees at it while keeping the same, the rest of the economic system the same. So at one point in Europe, in the world in 2020, there were $18 trillion worth of bonds in the world that had negative interest rates.

And that's because when someone buys a bond, there's two things they care about, three things. One is the credit worthiness of the entity of the bond, like a vacuum cleaner or a U.S. government have different credit things. Two is the interest rate risk, like what's going on in the economy. If the economy is going to slow, people will buy bonds because they expect interest rates to go down. And then the third component is the credit worthiness, like, do I believe that this entity can pay off this bond? For the longest time, no one is ever worried about the U.S. government being able to pay its debt.

And it's still, you know, like 1% credit default swaps or something on the U.S. government. I don't think that'll ever happen. But what does happen is banks get deposits and they pay very little money on those deposits. And then they invest the money, sometimes with leverage, often with leverage. And they buy longer term assets like mortgages or corporate bonds or other things. And they make money on the spread. they are getting 5% and they're only paying out 1%. But what happened with Silicon Valley Bank was as the Fed started to raise rates,

the short rates went up and up and up. And the securities they owned that they had bought three years ago at low rates went down in value. And the depositors wanted more money, more interest because two years, year rates are 4%, or they were before yesterday. So a lot of people started demanding more money on their cash, their checking account. And they moved their money out to other assets that would pay them more. Now, when they moved the money out, these banks no longer had the deposits in order to maintain the size balance sheet that they had. And so they had to sell securities. to raise cash. And so I don't think this was a solvency issue like we had in 2008, 2009. It was a

liquidity issue. And I think the powers that be came in and bailed out the depositors, which to be I actually think that is moral hazard. If we bail out, if wherever you deposit your money, you don't have to worry about it because someone will bail it out, that's an element of moral hazard. So I think they stemmed the bleeding for the short term. But what's going to happen is as interest rates fluctuate, and right now we've had a hundred basis point drop in what the federal funds rate ending point. on this tightening cycle will be, is that more and more investors may move their money out of

small and medium-sized banks towards banks that are J.P. Morgan, Citibank, and others, because they're totally guaranteed. I think another thing that's going to happen is that the 250,000 FDIC guaranteed number is probably going to have to increase. increase. So I think this crisis will probably be contained, but now here's the interesting part of this, frankly. First of all, I don't think Europe is remotely out of the woods on this. We've seen credit default swaps of one of Europe's largest bank credit Swiss go to around 30%, meaning there's a 30% chance that they default. What happened in Europe is they had a lot of the world's negative yielding debt. So there are a lot of European banks that still owned

securities that they bought at par or at 100 when rates were 1% or 0%, and now rates are much higher, so they're underwater on those positions. And meanwhile, they've had to tighten financial conditions because of inflation because of the biophysical shot across the bow from Putin, Ukraine-NATO situation, which, by the way, Europe dodged a huge biophysical bullet because we had a warm winter in Europe this year. And I don't think the Nord Stream or things like that are going to be repaired, if ever, certainly not this year. So next winter is going to be a big deal. Already, I think Germany had to create two trillion dollars of deficit to offset what happened this winter. So the bottom line is the European banks now have, in my opinion, probably a larger systemic

problem than even these banks like Silicon Valley Bank, etc. But what this all means is that eventually every time we hit a financial crisis, and I would argue the time interval between these financial crises will become smaller and smaller, the choice is to let things fail, let things implode, or to backstop them. And I think we've entered the financial big brother era where governments, if they can, will continue to backstop depositors, investors, assets. And this creates a eventually this will create a too big to save moment. So Lehman Brothers back 14 years ago now was said to be a too big to fail security.

It did fail. And what happened was the dominoes of de-leveraging in the financial system. At some point in the not too distant future, we will have to bail out France or Japan or the aggregate of J.P. Morgan and other banks or something like that. those entities will be so large that the Fed, the Bank of England, the ECB together couldn't bail them out. And then that's what kicks off the great simplification for more people. I think there eventually will be bank failures because what we're doing is we're papering over our financial claims that we can't meet with more financial claims.

So, you know, I think a too big to save moment is not here now. But in the same way that Russia and Ukraine situation was a little bit of a dress rehearsal, a wake-up call for people who are energy blind and didn't understand the vital importance that not only energy has to our economies, but cheap energy available at scale, I think this Silicon Valley Bank is starting to wake people up a little bit to what is money, how safe is it, why, what are banks and how do I earn interest and people are starting to ask those questions. And I think we've entered the biophysical vortex of every crisis will be met by a larger and larger government response until something breaks.

So listeners of this program, just think about this that I think this crisis will be contained, but the next one or the next one after that might not be. And so I think we have to really think about the safety of money. I care about how society is going to respond to this snapping back of a rubber band one day. And also, you know, personally reflect on is financial capital the best metric for one's self-worth? Natural human, built, and social capital are probably a better proxy. And use your financial capital now wisely to better set up your circumstances, your family, your community for that time in the future when this rubber band might snap back larger.

faster in a way that governments may not have immediate answers for. That's my two cents on this topic. By the time this is out, the world may have changed, but this is kind of the biophysical backdrop of how I see the banking situation. Have a good weekend. I will try to do this probability, identity, and certainty, frankly, next week. Thanks.