Had the central banks not intervened to bail out banks with taxpayers’ money in 2008 the world’s financial system would probably have collapsed. According to many economic pundits and business comentators the global economy looks riskier now: government debt levels are at record highs; big financial institutions have grown even bigger; and while we may not have a housing credit crisis brewing because few people can afford to buy houses, we are seeing financial stress in many areas, from student loans to instability in stock markets. At the same time income inequality has blown out of proportion and over – inflated asset prices hardly benefit the less privileged in society.
With hindsight, we can say the monetary policy of central banks around the world, (Quantitative Easing aka printing money) lulled politicians and investors into a false sense of security and that the unresolved problems from 2008, 2000, 1991 and back to the wall Street Crash of 1929 could still come back to haunt them? Or can they keep things under control with these newly minted economic theories such as negative interest rates (NIRP), i.e. savers and depositors pay the banks for lookig after their money (it is not a new idea at all, the system was used by medieval goldsmiths but was supereded by ‘fractional reserve banking’ in the seventeenth century.
Since then the focus has changed, the US Federal Reserve, made clear that the objective of monetary policy – and specifically quantitative easing – was basically to stimulate aggregate demand. And since then we have had all the central banks around the world pursuing that objective through increasingly whacky measures.
However, there is a fundamental shortcoming in using monetary policy in this way. The fundamental problem we all face is a problem of too much debt. In a sense it is a problem of insolvency. And relying on central banks to correct this is totally inappropriate, because they can handle problems of liquidity but they can’t handle problems of insolvency.
Now, why is this happening? Simples, the politicians find it convenient to believe that the central banks have it all under control.
But it’s not true, because what we have been doing is both losing control because efficiency of the Quantitative Easing seems to be getting diminishing, while the impact of unintended consequences, the side effects of money printing, are becoming more and more evident. In the end this has to cause bigger problems than it set out to solve.
And of all the unintended consequences, lulling the governments into a false sense of security is probably the most important.
In a modern financial economy, liquidity is created primarily by the banks through credit creation (magic money). When that liquidity creation slows down typically the economy falters. So as the banks were forced to deal with credit and balance sheet issues from 2008 onwards, the central banks stepped into that role by cheapening the cost of credit and conducting large scale asset purchases to make sure that liquidity continued to flow throughout the economy.
However, even that seems insufficient to rekindle economic growth, prompting some central banks to go a step further and adopt negative interest rates (“NIRP”). Japan is the latest convert but Germany and the US Federal Reserve are moving the same way.
After seven years of the slowest recovery ever, it seems to me that there is empirical support for the proposition that negative interest rates (licenced stealing of customers money by the banks) will not be any more suggessful than printing money (i.e. stealing peoples’ money by inflation and low interest rates thus robbing savers and investors of its true value.
Not only have quantitative easing, qualitative easing and now NIRP – has led many people to get the feeling bankers and governments are panicking, as a result of the associated uncertainty, they consumers have hunkered down instead of going out and spending the money as the theory promised they would.
There’s another point which is closely related. Think about interest rates being brought down to very low levels. The whole point is trying to attract spending from the future into today, what is known as ‘intertemporal reallocation’ (OK, that sounds like talking bollocks, I didn’t invent the phrase. If you bring spending forward (that’s what it means), at a certain point tomorrow has to become today and then future spending that you need to do is constrained by the spending that you have already done. And that manifests itself in increasing debt levels, which indeed we have already seen.
So, almost by definition, monetary policy only works for a relatively short period of time. We have had six or seven years of it at this point and I think that’s hardly a short period. There are all sorts of other issues that I won’t go into now, but in a nutshell what that means is we’re fucked.
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