Banking is one of the many peculiar features of the world that we use weekly, yet most of us understand very little about how it actually functions. So, when the collapse of a large bank hits the headlines, the results it produces seem almost random.
However, behind the scenes, there are clear cause-and-effect links between Silicon Valley Bank’s failure and problems with European banks and overseas startups. They underscore the importance of maintaining the U.S. dollar and tech hegemony in the face of calls for regionalizing economic systems.
Bank operations can indeed be quite complicated, but they boil down to one simple principle: buying at one price and selling at a higher one. Banks pay lower interest rates on the money they accept as deposits than they charge in higher interest rates for the money they lend, such as loans.
This spread is basically their profit. More specifically, banks make most of their profits from investing in short-term and long-term treasury bonds. When these drop in value, such as when interest rates rise, these spreads decrease and can even turn negative.
The problem is that a lot of the money banks lend out is not liquid enough to be easily recouped on short notice as the spreads decrease. When interest rates rise, long-term bonds and other safe investments cannot be sold without a loss due to the sudden flood of bonds being sold on the market.
A shock to the entire banking system can cause the value of other banks’ holdings to drop, which can cause problems. This is what happened with Credit Suisse, which was just sold to Union Bank of Switzerland indirectly as a result of the Fed raising interest rates aggressively.
The United States has long maintained its hand on the global financial tiller. Since Bretton Woods, the dollar has reigned supreme as the global reserve currency, even through the switch to the gold standard in 1971.
Some might argue that this grip is too strong, that the United States has too much influence over the economies of other countries, but I feel this one-sided view misses the value of centralization to exchange. Durability and commonality create assurance and trust — both essential for trade — especially in the hyper-elaborate modern financial system that often consists of derivatives built on derivatives built on derivatives.
What other country — or group of countries — can guarantee the social, economic and security stability that the United States does? Imperfect as it may be, the United States is the only option as the reserve currency and focal point of economic activity.
The Fed raising rates may throw foreign banks into chaos where a foreign bank would have a much more muted effect on our own, but this trade-off is worth it when the other option is a series of siloed economic hubs.
An additional angle in all of this is the role of tech — The United States also derives great influence from its role as the leader in developing new technologies. This technology makes a lot of money for the United States, but it also benefits the rest of the world. Naturally, Silicon Valley Bank sat prominently at this delta.
However, the bank’s failure also puts many international startups in a precarious position. India, for example, has been hit quite hard. With cash tied up, some companies have limited time for their funds to be recovered before they run out or need to raise new financing, which would further stress their balance sheets.
Seeing Indian companies in turmoil over an American bank collapse has driven further criticism of the United States’ influence, but again, this is misguided — without American platforms and financing, these companies wouldn’t exist in the first place. It’s reasonable enough to suggest that cushioning one region’s financial system from another might stabilize the global financial system, but the costs of this would require massive reorganization.
The coverage and commentary have actually been one positive aspect of the collapse. Putting aside all of the pompous calls for the decline of U.S. influence, media coverage has been fair and honest, not exaggerating the issue or spreading false rumors that have the world in a state of complete fear.
If we are to successfully maintain global stability through these decades of rapid technology-induced change, a strong entity at the center is essential, and for now, I feel the United States is the only option capable of serving that role.
Everybody quick! Bank run! Get back your money! Crash the global financial system!