The SVB bank failure shows us how

Last week’s failure of Silicon Valley Bank is a signal. It is putting us all on notice — not just that everything is changing, but that everything has already changed. Anyone who makes financial decisions going forward without realizing this puts themselves in extreme peril. The world is simply not the way it used to be.

Our New World of Managing Inflation

Back when the Fed first started raising interest rates to beat inflation, I wrote about how it would not work. Interest rate increases damper demand in an economy, but they do not affect supply — except by the unfortunate (in this case) sidelight of slowing investment in production, which would enable new production to meet demand. In an economic environment like the 1970s and early 1980s, where productive capacity is stable and there is enough supply to meet demand, increasing interest rates was particularly effective against inflation. It slowed demand and stabilized prices. Unfortunately, that’s not the environment we are in today.

Today we are in a supply shortage. Crops are failing all around the world as climate change alters the circumstances in which the crops grow. Pakistan underwater, countries burning, water running out… We know the list. These and other events are leading to lost crops and more expensive shipping. Fuels are less available because production is increasingly expensive and long-term investments in production and refining no longer make sense to fossil fuel companies. Clothing is less abundant because cotton and similar crops are failing. All of this adds up to a supply shortage, and where demand is not dropping, inflation occurs. But demand cannot drop by the 20% or 30% amounts that supply is dropping because people have essential needs. That’s inflationary whether interest rates restrict the money supply or not.

Having no other tools in their toolboxes, central banks start increasing interest rates anyway. But in this environment, the increased rates just add fuel to the fire. First, they add costs to the existing firms producing goods, which creates pressure to increase prices. Second, they prevent new production by slowing investment, thereby continuing to limit macro-level production. Decreasing supply plus ongoing demand increases prices. But in this case, the increased interest rates make the problem worse. Yes, some parts of the economy stall — like housing — and for a while, prices may stabilize. But the overall momentum does not change.

All the Risk Assumptions Have Changed

What does this have to do with SVB? Everything. You see, SVB’s original sin was investing in US Treasury bonds — otherwise known as the safest investment in the world. But they are not that safe in an economy with rapidly increasing interest rates. In fact, the price of such bonds goes down dramatically because who wants a $1,000 bond that pays, say, 1.25% when you can have one that pays 3%? If you can hold those bonds to maturity, they are safe. But if you have to liquidate them to raise cash, as SVB did, you lose a ton of money.

Right. So why does this matter? Because it shows how climate change has changed the financial system. The single most basic measure of an economy — its ability to produce for the needs of the population — has been altered by climate change. Not only can the system not produce to our collective macro-level needs, but also, the heretofore safest investment in the world is no longer safe. When climate-driven inflation hits, your investment will be significantly damaged either by runaway increases in interest rates driven by central bankers, or it will be damaged by runaway inflation driven by the inability to stop inflation. Either way, you lose. And, you will find yourself up against a terrible and growing shortage of products to meet your needs — be it food, clothing, fuel, or other economic essentials.

The problem for you and me, of course, is that we don’t control what the likes of SVB do with the money we deposit there, so any deposit we may make is at risk — much higher risk than we are used to assuming, and we have no idea how much risk they are taking. Worse, any company we might invest in could also be exposed to that kind of risk. SVB was heavy in start-ups. But where does Apple hold its cash hoard? Or Warren Buffett? No one knows when one of these stalwarts might find themselves on the short end of a similar financial collapse. Knowing the banks are susceptible, you have to take this into account. And “reputation” does nothing to protect you — just look at SVB.

For those of us trying to plan retirement, this is a particularly challenging time. For decades, financial planners have had their formulas for a safe retirement — some mix of stocks and bonds such that you can sell safe, risk-free bonds when cash is needed and let the stocks grow and slough off dividends. But if bonds are no longer safe, and if stocks are susceptible to the same kinds of crashes as banks in the financial system, does this advice still make sense?

Another option is real estate, but that creates an even worse problem as far as climate change is concerned. Today’s paradise could be tomorrow’s ash pile, as the people of Paradise, California tragically discovered. Not only investments are wiped out, but lives are destroyed.

What Can Those on the Brink of Retirement Do?

The first thing is to recognize the change. We are no longer in an economically stable environment. Look very closely at your plan and identify the underlying assumptions. What if those assumptions turn out not to be true? What if inflation cannot be tamed at any interest rate? What if climate change attacks your home — burns it, buries it, or dries it out to be uninhabitable? What if “safe” investments are not safe at all? What if global agricultural production drops by 20%, 30%, or 50% because the climate of key growing areas has become inhospitable for growing?

The dream of retirement has been to live on an asset-based income — that is, you have enough investments to draw dividends and interest to meet your needs. While it may work today, the changed risk profile means it may not work tomorrow. If that happens, what is your plan?

Given all this, prudence would say you have to maintain a non-asset-driven income stream. For some, that means to continue working. For me, and maybe for you, it means a digital nomad-type income, whether you travel or not. What do I mean? Let’s consider.

Here’s Your Plan

You have accumulated cash throughout your life and invested wisely, but as we have seen, you can’t count on that providing for you. The risk profile has changed dramatically. Invest it, yes. Do your best, yes. But the risk of loss has changed so substantially, that total dependence on it would be a fool’s game.

Add your social security and any pension you may have, but realize that, too, may be temporary given the realities of politics and the challenges the government will face as shortages caused by climate change expand.

Buy and wholly own a home. Make it small and modest, purchased in what you see as the least risk location for climate change impacts like fires, floods, droughts, hurricanes, sea level rise, and the like. Then reinforce it to handle short stints of terrible weather that could knock out your power. Don’t rely on the grid! This is your single most conservative investment, and by having it without any debt, you will have a place to go and wait out a catastrophe.

Better yet, have two such places so that if one is destroyed, you have a place to go. For example, a friend has a modest home in Minneapolis and a sailboat on Lake Superior. The boat provides alternative lodging in an emergency. During the season, it is a beautiful alternative. In winter, it can either be sailed away or resided in as it sits on its stands. He has fitted the boat with appropriate heaters and the like to accommodate this temporary residency if it becomes necessary.

If this sounds over the top, consider that people who owned cabins used them in exactly this way during the pandemic. Many left their homes in urban areas and lived in their cabins — if they could work from there. This is precisely how my friend would use his boat. It is prudent planning and aligns with the benefits of his regular life.

Finally, build and maintain that income stream that has no connection to geography. A continued income stream is your second most conservative investment. You need to have it. First, it means that you can bring in money in the current economic situation, whatever it may be. And second, it gives you the flexibility to take income with you if relocation becomes necessary. Yes, I am saying a safe retirement income should have a side-hustle component that can continue to generate income, and which might even grow or be able to be turned on at the time you need it.

Conclusion

These are the new elements of a new, safe retirement. It might be depressing. You probably won’t be able to fish your way to oblivion, or golf without concern for finances. But you can live well with a proper setup, and I would encourage everyone to create that setup.

Anthony Signorelli

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