Some of you well remember the last time we found ourselves in the place we are today. 

It was the era from 1979 to 1981. A brewing inflation over the 1970s began as a supply chain disruption. Reductions in petroleum supplies in the United States arose as OPEC nations embargoed oil destined for the U.S. as retaliation for U.S. support for Israel. Energy costs as a share of GDP rose to over 12%, which are almost three times the 4.4% burden today. Americans were driving big cars and heated poorly-insulated homes. We could not quickly adjust to accommodate higher energy costs, so more of our wealth inevitably went to purchase energy. 

We could have recognized our purchasing power must drop by 7% or so, at least until we could reduce consumption and increase domestic production. Instead, we sought to be indemnified through higher wages. 

This unwillingness or inability to quickly ramp up production over the last few years to accommodate energy pinches and a tight labor market post-COVID is forcing us to repeat the pattern that defined the 1979-1981 stagflation. History is repeating itself. 

This story of a supply shock that induced an inflation is familiar to readers of this page. We have even recognized that the closest analogy to our present circumstance is the 1979-81 stagflation. We know that the resulting wage inflation spiraled upward then, and is causing persistent inflation again, even as the Fed induces a recession, now and then. 

The other factor is the relationship between stagflation and banks. In the late 1970s, a new financial innovation offered households another place to put their money. These new money market mutual funds could offer competitive double digit interest rates while bank interest rates were capped. The 1933 depression-era Regulation Q prevented banks from matching the rates these new-fangled mutual funds could earn. More sophisticated depositors moved their money out of banks in droves, at least until the Depository Institutions Deregulation And Monetary Control Act of 1980 permitted a phase-out of interest rate ceilings by 1986. 

The same is happening now with fintech. Traditional banks cannot afford to offer high interest rates of short term deposits when it cannot earn a sufficiently high interest rate on longer term loans it may underwrite. Borrowers are reluctant to pay a high long term interest rate if they feel inflation is transitory and the Fed may have to soon lower rates to avoid a recession. And depositors are attracted to Internet-based near banks such as Apple that offer a 4% to 5% return. 

In fact, after a significant and unprecedented runup in bank deposits as two administrations threw money at households and businesses who had nowhere to spend during the COVID era, the banking industry has been experiencing an equally unprecedented fall in deposits. This fall in deposits is not because people are buying more stuff, although part of it is because we are paying more for the stuff we purchase because of inflation. Instead, there is a shift in assets out of banks and into mutual funds and brokerage houses that appear much like banks to many consumers. We can direct-deposit and electronically transfer between these accounts, and some even offer check writing privileges. 

This process is accelerated not because of a Reg Q that artificially held down bank interest rates on deposits, as in the 1970 and 1980s. Instead, banks are limited by an inability to earn sufficiently high returns on its lending to pay an interest rate some depositors currently expect. Just as money markets filled a void in 1980, fintech and even crypto and drawing away bank deposits. You may have even seen pitches from Discover Card, American Express, and other credit cards as they attempt to entice away your bank deposits. AMEX has seen a 33% increase in such near-bank deposits, while Discover has seen an 18% increase. Meanwhile, even Bank of America has seen a drop in deposits of 8%, while Wells Fargo has seen a 7% decline.

Not all banks experience the same challenges. Larger banks have an advantage in that they have more varied opportunities to invest their available deposits. Smaller banks are left to compete with a dwindling number of borrowers hunkering down because of recession fears. 

The perfect storm of a persistent wage-push inflation, deposits that are bled away from some banks, and interest rates forced up by the Fed at a rate unprecedented since 1979-81 and too fast to allow banks to adjust their balance sheet has created what we see today. The Fed is taking the most extraordinary steps since the Troubled Asset Relief Program (TARP) in 2008 to substitute cash for low-yield government bonds held by banks so they can accommodate customers who move their accounts elsewhere. 

The Fed has put in place their Bank Term Funding Program (BTFP) to ensure banks are not caught short by the recent dramatic rise in interest rates and the financial disintermediation it has caused. The last thing we need at this point in time is to make the perfect storm worse. The BTFP, a reincarnation of the TARP, but designed to absorb securities held by banks devalued by high interest rates instead of Mortgage-Backed Securities (MBS) riddled with sub-prime loans, is serving the same role. The Fed acts like the Empaths in the Star Trek episode who have a greater capacity to absorb pain and hence heal. Without this ability increasingly drawn on by banks, some would be unable to weather the deposit runoff that can occur once the market gets wind of a bank short on cash.

Who could have imagined that U.S. government bonds, the gold investment standard, could be a troubled asset on bank balance sheets? This could only have occurred with banks so flush with cash from government checks sent to their depositors that they exceeded their capacity to lend the funds out and instead parked them into (sometimes too long duration) U.S. bonds. While we have not seen this precise pattern before, what is occurring should not have been difficult to imagine. It is not that those who disregard history are destined to repeat it. No two recessions are identical, as are no two stagflations. But, these two unusual circumstances are similar enough to wonder why we did not realize the similarities today as we eventually had a half century ago.