Jake's View

San Francisco Fed chief's jobs claim holds no monetary water

Central banks can go some way to stimulating economic growth but they can't make borrowers drink from the dubious pool of money

PUBLISHED : Thursday, 08 November, 2012, 12:00am
UPDATED : Monday, 30 May, 2016, 2:05pm

Asset buying boosted US growth, Fed official says

SCMP headline, November 7

I am one of these people who treat elections as sport. It's great fun watching the results roll in on a close one and the enthusiasm is infectious. I think, however, that elections have less real effect on society than even a football game. Politicians are the captives of events, not the directors of them.

But I accept that some public officials can do much to change the course of events and here we have an example. John Williams, president of the San Francisco Federal Reserve Bank, was busy slapping himself on the back during US election week at the supposed success of US monetary policy.

He thinks the US Federal Reserve has done a wonderful job in using public funds to buy up huge amounts of dubious securities in the belief that this pushes up economic growth and creates jobs. We in Hong Kong are among the people who pay the price of this delusion. It's the heat under the fire of our property market at the moment.

Let's get something straight about monetary policy. No central bank on its own can stimulate an economy. This jockey can take its horse to water but it cannot make it drink.

Making the horse drink in monetary terms is convincing industry to borrow money from commercial banks. If industry doesn't want to then the economic stimulus won't happen, no matter how low the interest rates and how much money the central bank floods into the market.

It comes down to something called the multiplier effect. When a central bank puts an extra $10 into the monetary system it does so by lending that money to a commercial bank.

The bank then lends it to a customer who brings it back to the bank as a deposit. The bank then lends out this deposit again and round we go once more. This $10 of base money can quickly become $50 of money supply and even more if there is real demand. But it all depends on the bank customer wanting to borrow from the bank. If he doesn't, the bank just puts the money back into government bonds and the growth in money supply is no greater than the $10 increase in base money. This is exactly what has happened in America and Europe over the last few years. The banks cannot find borrowers and the stimulus money they get from the central bank just goes right back to the central bank.

It has happened because big corporate borrowers still feel burned by the 2008/09 financial crisis and are still concentrating on rebuilding the strength of their balance sheets rather than adding to them. It's the proper thing to do after a financial shock and this process probably still has a year or two to run.

But central bankers across the world are increasingly driven by the short-term objectives of politicians who do not understand monetary affairs. The politicians want instant job growth because they believe this will win them elections. They therefore want their central banks to push for instant economic growth, whatever the circumstances.

It is highly irresponsible. It threatens the underlying health of the economies that practise it. It is particularly irresponsible for central bankers such as Mr Williams to recommend it, and in the US it has taken a particularly bizarre form.

Central banks normally stimulate by providing the monetary system with plenty of money. This has not worked in the US (that multiplier effect won't multiply) and so the Fed is now acquiring US$40 billion a month of mortgage-backed securities.

This is the poison that brought the US economy low in 2008 and it is poison still.

The Fed is making the public buy the worst corporate assets in the US to bring corporations back to the borrowing market earlier than they might otherwise do so.

Did you ever hear as much as a peep of protest from either Obama or Romney about this enormous theft from the voters? No, you did not.

Do you still want to know why I think elections are just sporting events?