News of the week summary - 12/03/23

Silicon Valley Bank collapses

Founded in 1983, Silicon Valley Bank provides funding for tech companies, private equity and venture capital firms specialized in tech. It also runs a private bank service for wealthy individuals from the valley. It held more than 200B$ of assets before its collapse, and had a market capitalization of about 43B$ at its peak a bit more than a year ago.

In 2021, SVB’s assets and deposits almost doubled, which it massively invested in government debt securities (US treasuries mostly). However, the FED began raising interest rates shortly after, which provoked a decline in the value of treasury bonds emitted before the rate increase (because those are less profitable than the new ones so their value decreases on the secondary market), causing an increase in unrealized losses for the bank.

Chaos started when withdrawals exceeded deposit inflows, as clients burned cash and stopped getting funds from public offerings and fundraisings as a consequence of a harsher economic environment. SVB had to sell its assets to provide cash to its clients, resulting in 1.8B$ of losses for the bank.

On Thursday, SVB proposed to sell new shares of itself, to raise capital and shore up its balance sheet. Moody’s simultaneously downgraded the company’s rating. These two events worried clients who ran to withdraw their money, in fear the bank would become insolvent. The bank run degraded the situation even more, and on Friday the bank was shut down by the authorities, for inadequate liquidity and insolvency. Many start-ups now find themselves with a lack of cash to pay for immediate expenses like employees’ salaries.

This episode (the second biggest bank failure in American history) alarmed investors about the impact of the FED’s hawkish policy on banks, prompting a 52B$ decline in market capitalization for the four biggest American banks.

Another victim of SVB’s collapse is Circle Internet Financial’s USD Coin, a cryptocurrency designed to always be worth 1$. When Circle revealed it had 3.3B$ worth of deposits at SVB, holders of the currency rushed to cash out 2B$ worth of their coins, in fear it would become illiquid. The coin is now trading at around 85 cents because of this massive sale. This could send shock waves around the crypto world, as crypto investors hugely rely on stablecoins to store their money.

 

Chinese exports fall further despite the economy reopening.

Chinese exports fell by 6.8% in January and February compared to a year ago (the two months are regrouped to smooth out the effect of the Chinese New Year holiday on trade). Exports were supported by the easing of Covid restrictions, but interest rate increases in the West weaken the demand for imported goods and are likely to further dampen Chinese exports. Chinese businesses explain that covid restrictions and difficulties to obtain a visa have made it difficult for foreigners to deal with Chinese manufacturers.

As demand from the West shrivels, China’s economy is becoming increasingly dependent on its Asian neighbors. Indeed, although exports to the EU and the US fell by 12.2% and 21.8% year-over-year in the first two months of the year, exports to southeast Asia rose by 9%.

Meanwhile, China’s imports shrank by 10.2% in the first two months of the year compared to 2022. This led to an appreciation of the country’s trade surpluses, that now amounts to 117B$.

Supply chain difficulties and recession risk in the West pose an important threat to the Chinese economy, which still hugely relies on foreign demand. As a result, the government’s GDP growth target was set to 5%, a low level compared to pre-Covid growth (although higher than the 3% growth observed in 2022).

 

India progressively opens its economy to the West

In an effort to protect itself from China, India is increasing political and economic cooperation with the West.

India’s tariff for nations with which it doesn’t have a trade partnership, stands at a whopping 18% (it has increased by 5 percentage points since 2014). However, this tariff is aimed at “nontransparent economies who are dumping really low-quality, substandard goods at really low prices, which is hurting the Indian economy and Indian manufacturing” according to the country’s minister of commerce. The main target of this protectionist policy is China.

India signed free-trade deals with the UAE and Australia last year (but not on many sectors that are considered sensitive by India). Negotiations with the UE, UK and Canada are also well advanced.

The country is moving cautiously and the question for many observers is how far will it go? It presents itself as a potentially enormous market for foreign companies, without the state-interference and lack of transparency that could deter companies from investing in China. Tensions between the two most populous countries in the world have intensified since the border clash that left 24 soldiers dead in 2020. Yet, attempting to grow as a world economy while reducing dependence on China will prove tricky, as global supply chains rely heavily on the world’s second largest economy.

 

FED announces potential larger rate increases.

FED chair Jerome Powell said February reports on hiring and inflation will determine the size of the next rate increase, which he expects to be higher than previously expected as consumer spending and employment remain strong. According to SGH Macro advisors’ chief economist, Tim Duy, this means the FED assumes that it won’t be able to bring back inflation to 2% without putting the American economy in a recession.

 

Economic prospects profit from declining energy prices

Oil price has fell below its pre-war level (from 121$ to 77$ since the middle of last year). Natural gas prices have reached their lowest level since 2021 in Europe.

This translates into huge savings for European economies: France for example spent the equivalent of 2.5% of its GDP last year on gas and is expected to spend below 1% this year. Energy’s omnipresence in our economies means lower oil and gas prices will reduce costs for the state, and for every household and company.

However, since governments have deployed important energy subsidies to compensate rising prices last year, the boost provided by the decreasing prices will be diminished. Neil Shearing, chief economist at Capital Economics, thus expects the impact on output will be only be about half of the actual cost savings. According to the consulting firm, it will still be enough to boost eurozone output by about 1.5 percentage points. That means Capital Economics now expects the eurozone to avoid recession and grow by 0.7% in 2023. Lower prices will also improve consumer confidence and encourage spending.

The consequences will be more ambiguous in the United States, as it is a net exporter of oil. Lower energy prices means the money that would have gone to energy companies and their shareholders goes to other households. Empirical research shows that richer individuals spend a smaller part of their income, and companies do not invest 100% of their profit in America, so transferring that money to average households is likely to increase demand in the country (but less than in Europe).

Effects on inflation will work both ways : falling energy prices will lower headline inflation and reduce the need for employees to negotiate higher salaries to maintain their purchasing power (which can trigger a wage-price circle); they will also increase consumer spending and lead to higher prices if output cannot keep up with the climbing demand.