Modern monetary myths: Debunking the fallacies that lead to economic failure 

The story of Silicon Valley Bank’s failure should be a cautionary tale about the consequences of ignoring sound money principles. In December 2020, the Federal Reserve said that it expected its interest rate to remain at 0.1 percent through 2023. Today, rates are set at 4.5 percent. That rapid mismatch crushed SVB and will likely crush other banks. 

Relying on the Fed’s representations regarding low interest rates, SVB invested in Treasury bonds and mortgage-backed securities. If interest rates were low, these assets—which yield around 2.5 percent—constitute sound investments. When interest rates are high, these assets are no longer desirable because higher yielding products are available. 

When SVB faced a surge in withdrawals, it was forced to liquidate Treasury bonds and mortgage-backed securities at substantial discounts to generate cash. These very public losses made even very sophisticated customers lose confidence in SVB’s capitalization, precipitating the run. 

While the Federal Deposit Insurance Corporation has intervened to mitigate the SVB fallout, Congress and regulators must take steps to prevent these failures from happening in the first place. The critical first step is to debunk the economic fallacies that have gained traction in recent years. Proponents of these myths believe that we can ignore sound money principles to achieve economic growth or avoid economic pain. They could not be more wrong. 

Perhaps the most popular—and bipartisan—myth is that deficits do not matter. Proponents claim that the government can continue to spend beyond its means without consequence because the government can simply print money to make up the difference. This claim is simply untrue. When Congress increases spending, the Federal Reserve responds by increasing the money supply by purchasing treasury bonds from the open market. This simultaneously increases the money supply, and soaks up the supply of federal bonds, so that the government can issue new treasuries to finance deficit spending. Federal deficit spending ends with inflation. 

In response to the COVID-19 pandemic, the federal government spent more money than any lender would let us borrow. The Fed massively expanded its balance sheet by nearly $5 trillion. That monetary expansion did not help the economy, it caused record-breaking inflation. 

Finally, we must also reject the widely accepted idea that “expert” government officials can competently manipulate interest rates and economic policy to control the economy. For years, President Biden, Treasury Secretary Janet Yellen, and Federal Reserve Chairman Jerome Powell claimed inflation was transitory despite the clear evidence. Speaker Nancy Pelosi (D-Calif.) and Senate Majority Leader Chuck Schumer (D-N.Y.) also falsely claimed that additional government spending in the Inflation Reduction Act would bring inflation under control, despite the obvious effects of their spending plan. Over relying on Congress’ fiscal policy and the Federal Reserve’s ability to set rates distorts economic signals and creates imbalances that can lead to economic bubbles and crashes.  

SVB’s management undoubtably made mistakes: a concentrated customer base and reliance on uninsured deposits were major contributors to its collapse. SVB also failed to manage interest rate risk by relying on price signals and macro-economic policies controlled by Congress, the president, and the Federal Reserve. As other banks review their balance sheets for interest rate risks, how many financial institutions relied on price signals created by the Federal Reserve and the Biden administration?  

While we sort through immediate next steps and surveil the market for similar risks, we swiftly agree that mistakes helped create this crisis. Sound Money is essential to a sound economy. The toxic blend of Modern Monetary Myths is crippling our economy. Before it’s too late, America must reject the myths that have led us down a proven path towards economic failure. We must embrace sound money principles, limit deficits, and let the market determine interest rates. By doing so, we can build a stronger and more resilient economy that benefits all Americans.  

Warren Davidson is a member of the House Financial Services Committee.