A Credit Crunch Is Inevitable, by Daniel Lacalle

The global debt bubble is imploding and yes, that makes a credit crunch (which is too innocuous a term for what’s going to happen) inevitable. From Daniel Lacalle at mises.org:

Federal Reserve data shows $98 billion of deposits left the banking system in the week after the Silicon Valley Bank collapse. Most of the money went to money-market funds, as the Bloomberg data shows that assets in this class rose by $121 billion in the same period. The data shows the challenges of the banking system in the middle of a confidence crisis.

However, as many analysts point out, this is not necessarily the main factor that dictates the risk of a credit crunch. Deposit flight is certainly an important risk. Many regional banks will have to cut lending to families and businesses as deposits shrink, but in the United States bank loans are less than 19 percent of corporate credit according to the IMF, while in the euro area it is more than 80 percent. What will generate a credit crunch is the destruction of capital in the asset base of most lenders.

The slump in mark-to-market valuations of all asset classes from loans to investments is what will ultimately drive an inevitable credit contraction.

Credit standards have tightened significantly already, and the credit impulse of the economy, both in the US and euro area, has deteriorated rapidly, according to the respective Bloomberg indices. Both are below the March 2021 low.

We must remember that credit standards’ tightening was already a reality before the Silicon Valley Bank demise. But the reality check of capital destruction in the financial system’s asset base is far from done.

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