Central banking used to be an august profession ― highly respected, almost revered, mainly because they looked after everybody’s money. But now that Wall Street can print more money than God, and the Fed and European Central Bank are still printing money to keep their economies from deflating, central bankers have lost their god-like status.
Every year in August, the Federal Reserve Bank of Kansas would host an event in Jackson Hole for central bankers and key thinkers about money to debate the international economy. In the 2005 Jackson Hole event, then IMF Economic Counselor Rajan Raguram asked the question: “Has financial development made the world riskier?”, and was famously dismissed by the central banking community present, including Larry Summers, then U.S. treasury secretary, who called the paper “mildly Luddite,” referring to those who resisted the Industrial Revolution.
This year, in the midst of one of the most uncertain summers on the direction of the international economy, with Super Mario seemingly alone staving off the barbarians at the European debt gate, the Jackson Hole conference will be held in September, so we do not have the benefit of wisdom culled by the central banking community to prepare us for the second half of the year.
In its June 2012 Annual Report, no less than the Bank for International Settlements (BIS) has warned against the effects of quantitative easing and low interest rate policies (read: printing money): “Failing to appreciate the limits of monetary policy can lead to central banks being overburdened, with potentially serious adverse consequences. Prolonged and aggressive monetary accommodation has side effects that may delay the return to a self-sustaining recovery and may create risks for financial and price stability globally.
The growing gap between what central banks are expected to deliver and what they can actually deliver could in the longer term undermine their credibility and operational autonomy.” Even the BIS thinks that low interest rates “could perpetuate weak balance sheets and lead to a misallocation of credit.”
Back in 2009, as a former central banker, I warned at the Federal Reserve Bank of Chicago Conference about the dangers of quantitative easing and zero interest rate policies, which effectively meant passing the losses of the advanced country crises to emerging markets and all holders of their financial paper.
The real question of this current crisis, which originated from too much consumption financed by too much debt, is that central banks are trying to keep their asset bubbles from deflating through expanding their balance sheets, including buying unorthodox papers.
We have an odd situation whereby the outgoing American adviser on the Bank of England’s Monetary Policy Committee urged the bank to buy more private-sector assets other than government bonds. This raises the question of whether central banks have become lenders of first resort ― front-line lenders to the private sector, instead of being the banker to the banks and therefore lender of last resort. In many advanced economies, bank lending to the real sector is still flat or negative.
No one disputes the duty of central banks to provide liquidity in order to prevent total financial meltdown. The Bagehot Rule, devised by the 19th century English economist Walter Bagehot, argued that during a crisis, the central bank should lend freely, but against good collateral and at penalty interest rates. Unconventional times require unconventional tools and solutions.
But QE2, LTRO and other unconventional central bank action essentially meant providing liquidity to postpone painful decisions because politically it is difficult to implement painful fiscal adjustments, such as raising taxes to cut excess consumption. The risk is that central bankers who are supposed to take away the punch bowl are adding fizz to the bubbles, while the man on the street is facing unemployment and angry over being evicted because of defaulted mortgages.
In a new book, Robert Pringle, editor of the Central Banking Journal, argues that the world is in “The Money Trap” (Palgrave Macmillan 2012) that “squeezes the life out of business and trade” and that policymakers will only be able to get out of this trap if they (1) “have a correct analysis of how we got into the trap; (2) that they act at the right level, which is that of the global financial system as a whole; and (3) that they have the guts to face down their over-mighty subjects ― the princes of private finance.”
Pringle is absolutely correct in identifying the culprit as the international financial system, but the problem lay not in an ideal architecture, which may politically be impossible to achieve, but in the nexus of global money with national sovereignty. This is the primary global contradiction ― no nation is willing to concede sovereignty to a single global central bank, fiscal authority or financial regulator.
This contradiction is at the heart of the European crisis ― how to act quickly when you are trying to get a democratic consensus decision from 17 separate governments, legislatures and judiciaries, each of whom can put a spanner in the works and plunge the financial markets into another round of panic.
I agree with Pringle that we must anchor global money not against national credit, but a globally diversified equity basket, being a claim on the world’s real assets, which he called an Ikon. Theoretically, that is impeccable, but, identification of the Money Trap (more a collective action trap at the national and global level) is easier than reaching a solution. The heart of the problem of collective action traps (inability to get clarity on decisions that affect our future) is political. Central bankers are meant to be independent of the political process, but their technical tools cannot substitute for tough political decisions, which are not theirs to make.
Politics is about making tough choices, which either have to be made, or crises will make the decision for everyone. People tend to forget that not making a decision is also a decision.
By Andrew Sheng
Andrew Sheng is president of the Fung Global Institute, a Hong Kong-based, independent and non-profit think tank. ― Ed.
(Asia News Network)