The US navy is grappling with a costly error. After the attacks of 9/11 the military was planning how it might deal with a new type of enemy – terrorists. A new ship was dreamed up – it was extremely fast, it could travel in shallow water focusing on likely enemies coming from the Middle East.
The littoral combat ship, which The New York Times’ The Daily podcast described as a street fighter, “the MacGyver of the seas”, was created. Several issues emerged with the ships themselves but the big problem now is that terrorism is no longer the main defence worry for the US – it’s a potential war with China.
A military saying that generals prepare for the last war and not the next war springs to mind – and could equally apply to the mayhem hitting the financial sector in recent days.
Have regulators and policymakers been so focused on the mistakes of the financial crisis of 2008 that they have failed to anticipate some of the risks which lie ahead?
On the face of it inflation looks simple – something that was €4 in a local shop is suddenly €4.50
The problems faced by the now-collapsed Silicon Valley Bank were closely linked to inflation and what is now 12 months of Fed interest rate rises. The bank had built up a portfolio of long term bonds – which are worth less at the moment thanks to that Fed hiking cycle.
Contagion from Silicon Valley spread, shattering bank investor nerves and feeding into Credit Suisse’s long-running problems. It sent banking stocks across the world on a stomach-churning roller coaster ride.
What recent events have illustrated is what an insidious force inflation can be and how difficult it is to get under control.
On the face of it inflation looks simple – something that was €4 in a local shop is suddenly €4.50. We’ve all seen that first hand in recent months.
But once it starts there is a danger of a runaway effect. One price increase is fine, but when it is across the board, consumers begin to worry. We ask: Can I afford to go on holiday? Can I build my extension? Do I need a pay rise? Behaviour changes.
Businesses are no different and at a point, uncertainty takes hold. The effects of inflation are unsettling in a very fundamental way.
The only lever that governments, policy makers and central banks have is to make money more expensive.
Through higher interest rates, they have to take money out of people’s pockets – not necessarily everyone’s pockets but enough to reduce the flow of money by reducing capacity to borrow. Someone who could have borrowed money for an extension won’t be able to afford it now, builders won’t get a job, materials won’t be bought.
But rising interest rates are a very crude lever and one of the unexpected side-effects has emerged over the last week or so. Very few people saw it coming.
So in the US, policymakers now face a big dilemma. Will the steps they need to take to tackle inflation by raising interest rates have new and potentially very damaging consequences for the financial sector and the real economy?
Meanwhile, the ECB took the plunge on Thursday, increasing its benchmark rate by 50 basis points. When will the rate rises end? For Irish consumers who are paying more and more to service their mortgages, there is no sign that this pain was paying off.
The state will step in when trouble hits and that heavier regulation will be the cost
Figures from the Central Statistics Office last week showed that the annual rate of inflation rose to 8.5pc in February compared to 7.8pc in January. Food, restaurant prices, clothing prices and other outgoings are continuing to climb.
When it comes to banking, the nerves of recent days will hopefully settle down – although we are now in an extremely unpredictable patch.
In the US, recent events are likely to lead to more regulation and consolidation in banking.
Banks are so fundamental to functioning societies and economies that keeping confidence in the sector is essential.
That means the state will step in when trouble hits and that heavier regulation will be the cost.
The last couple of weeks has shown us a couple of things – that the financial system and central banks might not be ready for the next war and are unlikely to know where the next threat will come from.
A balance sheet mismatch caused by rising interest rates is just the latest problem to hit the financial sector in recent months.
Liz Truss’s UK mini-budget nearly caused a pension meltdown last year. We’re not quite as well prepared for another financial crisis as we think.
The past couple of weeks have also highlighted just what a concern inflation is and how crude a tool interest rate rises are.
Inflation has the potential to be quite destabilising. There was hope it might be a one year ‘transitory’ phenomenon.
The problem is that inflation has shown it is self-reinforcing and could have a much longer tail than anyone would wish.