Who’s sneezing,
and who’s most likely
to catch a cold,
asks James Meadway

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After a year in which the pound dropped precipitously against the dollar and the euro, losing, by autumn, about a third of its value of January 2022, the news in the financial press this week has been some excitable talk about an impressive recovery in the last few months. Speculators in the currency markets think that not only is the risk of a recession in Britain this year diminishing, but that the Bank of England is going to stick to its guns on interest rate rises – something Bank officials have also been keen to stress. After three torrid years, is everything finally coming up roses?

Sadly, almost certainly not. Turmoil in the US and European banking systems has not had much impact on Britain as yet, beyond the very hasty overnight sale of Silicon Valley Bank’s UK branch to HSBC. But even if the banks based here are less exposed – as far as anyone can tell – to the kind of stupidly risky investments they had taken before the 2008 crash, that doesn’t mean the financial tremors across the globe won’t have an impact.

In particular, it’s those smaller US banks, like Silicon Valley Bank, that should trouble us. The old saying about the US still applies – when America sneezes, the rest of the world catches a cold. Right now, those smaller US banks are pretty well laid up in bed with a fever. A record $109 billion was withdrawn from them in just a single week after Silicon Valley and two other smaller banks failed. Panicky depositors were worried, not unreasonably, that other, smaller banks were also at risk of collapse – creating a dangerously self-fulfilling prophecy called a bank run, when so many depositors rush to take their money out, in the belief that a bank is unsafe, that the bank actually becomes unsafe.

The US government has stepped in with hefty promises of support, in effect guaranteeing the safety of everyone’s deposits, but has left many smaller banks in a zombie-like state – not failing, but too scared to make loans and grow. And with these smaller banks supplying around two-thirds of loans to smaller businesses in the US, if they stop lending, that has a serious knock-on effect for the rest of the economy. A credit crunch like this would almost certainly drag the US into recession – and much of the rest of the world behind it.

On the other side of the Pacific, there’s a similar story bubbling away in China, which for years has fuelled its spectacular boom through banks making cheap loans to property companies. The result has been that property now makes around 29 per cent of China’s GDP – and that the country is littered with empty speculative developments, developers having over-invested and over-built ahead of any demand. One estimate suggested around one-fifth, or around 65 million, of its urban properties were empty – enough to house the population of France.

Even China’s dramatic growth, with its great migration from the land into the cities, hasn’t been enough to keep up with this frantic building boom, leading to property company failures over the last few years, like Evergrande Group, the world’s most indebted developer. Those failing companies in turn put pressure on the banks that loaned them money that is now much less likely to be repaid.

Like the US, the Chinese government has been stepping in to prop the system up, with the cabinet and bank regulators pushing major banks to extend more credit to property companies. But other debt crises threaten economic stability, with China’s local and regional governments, heavily dependent on property taxes, also increasingly overwhelmed with debt. The costs of fighting Covid have been particularly severe for regional governments – Guangdong province, in south-western China, revealed last week that it had spent more than $22 billion tackling the virus.

Unlike our comparative insulation from smaller US banks, Britain’s banks have the largest exposure to China of any foreign investors there. Banks headquartered in Britain have extended over $208 billion in credit to China, or not far off 20 per cent of all foreign bank lending. Tremors in the financial system there could move rapidly into British institutions, which have, over the last year, been reducing their exposure after many year’s growth.

Britain may well avoid a technical recession this year as the government’s official forecasts predict. But with the strains starting to show in the global financial system, it’s unlikely that road ahead will exactly be smooth. With prices for food, in particular, still rising, and the Bank of England still determined to jam up interest rates, most of us are unlikely to feel much better off, even if the overall rate of inflation falls. Whatever the currency speculators think, the basic problem of the cost of living crisis remains – prices are too high, and people’s wages and salaries are too low.

James Meadway is an economist and director of the Progressive Economy Forum, an independent thinktank (progressiveeconomyforum.com)

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