EconoMatters

Dismantle the Central Banks!

Central banks have served as a low-risk road to fortune for those with already ample financial assets.

Credit: Orhan Cam Shutterstock.com

Takeaways


  • “Leverage” became the fuel of the markets. “Debt” became the answer to all problems we might face.
  • The world economy has never been higher in debt. We are reaching the limit of debt capacity.
  • Central bank policies have been a low-risk street to fortune for those who could play the game.
  • The US Fed and all the central banks are working for the good of a small group – not the society.

It’s over. Trust in the once almighty power of the central banks has almost completely vanished. Sure, there are still some holdouts who believe that central banks could fix all problems in the real economy as well as in financial markets, primarily by just printing more money.

As becomes clearer every day, central banks are not going to help us out of the crisis. They are the ones who got us into it and make it worse every time they intervene.

Read Daniel Stelter’s Two-Part Essay on Relevance of Central Banks

Part I: Dismantle the Central Banks!

Part II: Central Banks as Relentless Boosters of the Rich

That is the “medicine” they have prescribed for more than 30 years already. It is time to stop them!

To be very clear: Without the central bank policies of the past thirty years, we would not have a global debt crisis, no asset bubble, no discussion on inequality and no deflation.

Oil would also not be at $30. Don’t believe it? Let me jog your memory.

Debt bonanza

The “Greenspan Put” is firmly in the Wall Street dictionary. Whenever there was some turbulence in financial markets or the economy, the U.S. Fed – and, along with it, all major central banks in the world – came sailing to the rescue. Lower interest rates and more “liquidity” (read: money) were injected.

The result? The crash of 1987, the Russian crisis, the Asian crisis, the LTCM bankruptcy, dot-com-bubble and the global financial crisis. In all cases, speculators and banks knew that the central bankers had their back.

Given the U.S. Fed’s path, the other major central banks of the world really had no choice but to follow.

The price of not following Washington’s command would have been to risk a steep appreciation of their own currency and a loss of export competitiveness.

Here is the remarkable development: Contrary to the constant soothsaying by Mr. Greenspan et al., after each of these crises, interest rates never returned to pre-crisis levels.

As the Bank for International Settlements has warned for years, this asymmetric reaction on the part of central banks laid the foundations for an ever-bigger crisis, forcing the already low interest rates lower still. The new central banking mantra? Low rates today require even lower rates tomorrow.

No wonder, then, that rates went lower and lower for decades. It became more and more attractive to work with borrowed money. “Leverage” became the fuel of the markets. “Debt” became the answer to all problems we might face.

Using leverage for financial gains

More competition from China leads to downward pressure on wages? No problem, just embark on a strategy where everybody gets rich by buying real estate, even with no money down (as the U.S. did so spectacularly).

More competition leads to higher unemployment? That’s no problem. After all, we have social welfare (that was the preferred European solution).

The rationale remains the same in either case: The higher the leverage given of a system, the higher the probability of a crisis.

This “logic” forced central banks to intervene even more, creating even stronger incentives to borrow and to use leverage for financial gains. The medicine provided by the central banks made the addicts more addicted.

The result: Never before has the world economy been as highly in debt as it is today. We are reaching the limit of debt capacity. All those able and willing to take on debt are already heavily in debt.

An ever-bigger proportion of new debt is just taken on the pretense to “serve” already outstanding debt.

The practical result of that is that the old justification – generating a demand effect for the economy — is shrinking rapidly. Et voila, we enter the secular stagnation.

Piketty would be an unknown economist

Closely linked to the debt wave is the development of asset prices. One hundred of the 400 richest Americans made their fortune with “investments,“ most of them with cheap credit.

Similarly, banks, hedge funds and private equity firms achieve their impressive returns only thanks to extreme leverage.

The mechanism is well known: As others ride this bandwagon as well, the demand for the stock goes up, leading to higher prices. This not only makes some people even richer, but they can even borrow more to buy more stocks.

The lower the interest rates and the lower the required equity, the higher asset prices can and will rise.

The policies of the central banks for the past 30 years were therefore nothing other than a one-way, low-risk street to fortune for those who could play the game.

Without the central banks, Thomas Piketty who wrote the best-selling book “Capital in the 21st Century,” a heavy treatise about inequality, would have had to look for another research topic.

Catering only to a select few

But even though his book runs some 800 pages, he did not make the connection that growing wealth and inequality were closely linked to the debt super-cycle of the past 30 years. He is thus describing symptoms, not causes.

Alas, even today it is becoming only very gradually clearer to the general public that the central banks – supposedly geared toward protecting the safety and soundness of the financial system — benefit only those with assets.

In its arrogance, the U.S. Federal Reserve even made this dismal concept its official economic strategy. It declared that a “wealth effect” would lead to more consumption — and therefore help the real economy.

This might work in theory, but not in practice. People equipped with high incomes and wealth tend to save more and consume less. Thus, the net effect of this central bank “strategy” is less consumption and less growth. Read: More accumulation at the very top, more despair at the bottom.

Make no mistake about it: The U.S. Fed – and all the central banks that followed it so eagerly — are not working for the good of overall society — just for the good of a small group.

It is only logical that Ben Bernanke, one of the biggest proponents of this policy, joined the hedge fund Citadel after stepping down as Fed Chair. High time for him to cash in himself on the cheap money and unlimited leverage “strategy.”

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About Daniel Stelter

Daniel Stelter is the founder of the German think tank Beyond the Obvious and former member of Boston Consulting Group’s Executive Committee . [Germany] Follow him @thinkBTO

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