Central banks’ impotent policies pose a greater economic threat

The way things are going depositors will have to pay a storage fee to the bank for holding their money

PUBLISHED : Thursday, 23 June, 2016, 2:17pm
UPDATED : Thursday, 23 June, 2016, 2:17pm

Brexit was only a distraction because there are greater threats of economic disruption out there. In their halcyon days, a central banker was a Master of the Universe who could move markets with hollow pronouncements such as “to do whatever it takes” to calm the markets. Now that interest rates are drifting below zero and economic growth remains weak, central bankers are faced with the dire consequences of their impotent policies. The resulting bubbles and market distortions will only lead to another financial crash.

Mortgage rates are so low some countries are effectively paying people to take out a mortgage. Over US$10 trillion in bonds are trading globally with negative yields. Negative yields force bondholders to pay the issuer for the right to lend money. The number of bonds with negative yields continues to grow. The fixed income derivatives markets are being compelled to price yields at levels never seen before in modern history.

The financial system and banks that were hit by the subprime crisis, a debt implosion, could only be rescued and remedied by printing money and creating even more debt. It could only be reduced by strong economic growth (inflating it away) or a massive write down, deflation or crash.

In 2002, at the National Economists Club, Ben S. Bernanke said, “I am confident that the Fed would take whatever means necessary to prevent significant deflation in the US. The US central bank has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief. Under a fiat money system a government should always be able to generate increased nominal spending and inflation, even when the short term nominal interest rate is zero.” Unfortunately, that policy has now been fully spent.

The world economy is facing a dead end confronted with chronic stagnation and decline

This speech helped to convince the political leadership that Bernanke had the expertise to lead the Federal Reserve. However, it was made in a very different monetary environment. The preceding 20 years from 1982 to 2001 represented the best of times for central banking.

It began with victory over pernicious inflation throughout the 1970s. Central banks’ credibility rested upon an economic cycle of mild inflation of about 2 per cent per year that could be maintained indefinitely with minor changes.

Instead, what you see today is a Federal Reserve that appears confused and indecisive. Or they realise they are actually out of capacity to print cheap money and they can’t admit it, especially during one of the most volatile election years in American history.

The hopes and dreams of America’s middle class have long since vanished underneath a sea of debt. Western capitalism has become a political exercise in managing diminished expectations. The world economy is facing a dead end confronted with chronic stagnation and decline. The last time capitalism faced this problem was during the Great Depression, which was only interrupted by World War II, resulting in the death of over 50 million people.

Central banks have created free money for financiers, but they can’t jump start the real economy. Instead they can only distort and cripple it with unhealthy incentives for speculation. American households are still crushed by debt. Based on the most recent Federal Reserve, flow-of-funds report for the first quarter, households now have record debt of US$14.3 trillion.

Ben Bernanke believed that, “Higher stock prices will boost consumer wealth and help increase confidence, which can also spur consumer wealth and help increase confidence, which can also spur spending (that) will lead to higher incomes profits that in a virtuous circle, will further support economic expansion.” This now appears like a series of tattered assumptions.

In this “new normal” scenario, the interest charged to member banks on their reserves by central banks will eventually and cruelly be passed on to consumers. Customers will eventually be convinced to stop grumbling and accept this travesty along with their other bank charges.

Central banks will someday remove the charge to their member banks, but the member banks might never remove the negative rates charged to their customers. It will become the new banking experience. Depositors will from then on pay a storage fee to the bank for holding money.

History teaches us with unmistakable emphasis that those who look, but do not see, live in the house of the blind. Status quo has failed. It is beyond redemption.

Peter Guy is a financial writer and former international banker