A quick recap of the last few weeks.
First, Silicon Valley Bank got into solvency problems and filed for bankruptcy.
“Solvency problems” doesn’t really mean much to most people, so let’s break down what really happened.
When you deposit money into a bank, they don’t just put that money in a safe and smile about it.
They do stuff with it.
Often they lend it out to people for mortgages and things like that.
But often they invest it too.
As I’m sure you remember, the last few years have been rather uncomfortable for investing.
Covid turned the world upside down, equity markets yo’yo’ed around and investing in general was considered kind of “risky”.
However, as I said, banks can’t just take your money and look at it.
They need to do something with it.
Naturally, many of them did what they thought was “safe” and invested in fixed interest investments, like bonds.
Bonds are considered safe because you get interest payments regularly, and then at the end you get your money back. Kind of like a term deposit.
Has anyone ever told you a term deposit is “risky”?
But then something happened.
The government started raising interest rates.
Now, some of you might be thinking, no big deal. That was expected.
No, it wasn’t.
In fact, I remember several very smart people back in 2020 and 2021 – people like CEOs, billionaires – saying they were absolutely positively certain that rates could not go up.
We were in a pandemic. The world had been locked down for two years. Businesses were going bankrupt left and right. You’re supposed to raise interest rates when the economy is booming. Why would you raise rates when they economy has literally been dead for two whole years with the entire world locked in their homes hiding from a virus?
But the world has a way of surprising you.
Not only did interest rates go up, they went up a lot, and fast.
Rates were at zero, then almost overnight they were at 4%.
Now consider this – what happens to a 10 year bond paying 1%, when you can get 4% just from sticking your money in the bank?
That bond becomes close to worthless.
But here’s the catch – banks like Silicon Valley Bank were investing in those bonds, because they thought they were safe. Stocks go up and down like a yoyo, but bonds are predictable and you can’t lose money, right?
Unfortunately, if a bank account is paying 4% and you own a bond paying 1%, that bond is now worth maybe 25 cents on the dollar.
Because why would anyone want a bond that pays 1%, when interest rates are 4%?
This means if you purchased $10 billion in bonds, it’s now only worth $2.5 billion.
Technically, this isn’t a problem. You haven’t lost any money yet. You could just wait ten years, and then you’ll get all your money out.
But here’s the catch:
To buy that $10 billion in bonds, you used the $10 billion that your customers had deposited. So if you’re able to wait 10 years, great, but ….
What happens if those customers want to withdraw their $10 billion today?
That’s right – you need to sell those bonds to pay them back.
But when you sell them, you don’t get $10 billion. You get $2.5 billion.
Now you’re $7.5 billion in the hole, and there’s no way for you to get it back.
And that, ladies and gentlemen, is how a bank files for bankruptcy.
So what happens now?
Well, banks don’t often fail in isolation.
All banks are interconnected in some way, so often when one bank fails, it affects another bank, which affects another bank, and on goes the chain reaction.
In the past week, three US banks have filed for bankruptcy – Silicon Valley Bank, Signature Bank and Silvergate Bank.
These represent the second and third largest bank failures in US history.
I am 99.9% sure more will follow.
By all reports, Credit Suisse is already teetering on the edge.
Who knows how many more.
Regardless, here’s what’s going to happen.
People are going to start withdrawing money from banks.
A lot of people, and a lot of money.
If two of the largest banks in US history have just gone bankrupt, are you really going to risk leaving your money in the bank?
So the next question is – what happens when people en masse start withdrawing their money from banks?
It will expose even more banks that are insolvent, who are holding assets like those worthless bonds.
Wall Street Journal agrees:
So what happens next?
The government has to step in to stop more banks from falling over.
Technically, the banks are not insolvent. They just have liquidity problems.
If they could just wait until the bonds mature and get their money out, they would be just fine.
But they can’t.
This means the government is going to need to provide liquidity, and in this scenario the government only has one magic act which is to print more money.
Printing money leads to one thing – inflation.
And printing lots and lots of money leads to … lots and lots of inflation.
My prediction is the US government is going to print eye-watering amounts of money throughout the next three months and probably most of 2023.
This is going to lead to higher interest rates for longer, but more importantly, it’s going to lead to much higher inflation than we are seeing now.
This inflation is going to mean heavy devaluing of the dollar – essentially these two things – dollar losing value and inflation – are the same thing.
This is also going to likely lead to a very volatile stock market, bond market and real estate market.
So where do you put your money?
What you need is an asset that cannot be inflated, that is not tied to any individual economy or government, and will hold its purchasing power.
The more I think about this, the more I get led in a circle and back to the same answer every single time.
The logical answer is Bitcoin.