What Options Are Left for Central Banks?

Central banks have reached a fork in the road.

Never before have quasi-omnipotent financial gods had so few powers. A lot is being written about central bank policies now as the Federal Reserve ends its primary quantitative easing (QE) program and the limitations of central bank easing become increasingly apparent in Europe and Japan.

Let’s start by listing the tools central banks have on hand. Strip away the fancy footwork and econospeak mumbo-jumbo, and what’s left is:

1. Offer cheap credit to the banking sector, the idea being that the banks will use the free money to make loans to households and businesses. These new loans would inject the central banks’ new money into the real economy.

2. Buy bonds to push interest rates down and buy mortgages to support the housing market.

3. Provide unlimited liquidity so banks and key financial institutions facing a liquidity crunch have a lender of last resort.

The basic idea here is that central banks provide a buffer against financial crises. When short-term loans come due and the borrower has run out of cash, rather than slip into insolvency they can borrow short-term money from the central bank.

The ability to push down interest rates is helpful as a buffer when credit-tightening and fear of defaults push interest rates up enough to choke off normal lending.

What happened over the past six years is that central banks have moved from providing short-term buffers to being the saviors of the government, economy and asset markets. This is an extraordinary transformation, and it’s the core reason why central bank policies are now failing to move the needle: they were designed to serve as short-term buffers during crisis and the resulting recession, not permanent props under government borrowing, the financial sector and the stock, bond and real estate markets.

Every conventional analyst expected the global economy to recover quickly after the central banks provided the usual buffer. But they were wrong; the structural problems stemming from financialization–excessive debt, leverage, risk and opacity–coupled with near-zero oversight and perverse incentives have wreaked havoc on economies around the world.

On Monday, I suggested central banks would resort to buying stocks to prop up the stock market: Will the Fed Let the Stock Market Crash Before an Election? Reports suggest central banks and states are already buyers of equities, either via proxies or via public pension funds that have increased their ownership of equities.

Central banks have reached a fork in the road. The policies have the past six years– jawboning, i.e. talking up the power of the central banks, buying bonds and shoving new money into the financial sector–have reached diminishing returns. The public’s once unbounded faith in the efficacy and power of these policies is waning, and now central banks face open skepticism.

One path is to admit the limits of central bank powers. This is tough to do when you’ve been glorified for so long, but the honest confession of the limits of making short-term buffers into permanent policies would force governments to deal with the issues that have been avoided for the entire six years of central bank free money.

The second path is to start buying assets en masse. With jawboning and easing both discredited, there really is nothing else the central banks can do to support asset prices and keep the thin veneer of a healthy economy from peeling off.

The third choice–continue jawboning and launching yet another failed easing program–will only further discredit central banks and their policies. 


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  • Bruce

    Governments always want money to spend on whatever foolish plans they can conceive, but without raising the ire of the citizens of the nation. In early times, gold and silver were money and kings and rulers could not wage war, or spend recklessly without it, else the peasants would revolt. This is tricky business, but now it can be done for a time by sleight of hand with the complicity of the banking interests and fiat currency.

    However, as history shows, this always ends badly. There is no beating around the bush here. The End Game for this folly will be an ultimate collapse of the entire system. History repeats. The end result is always the same. We are not there yet, but closing in. Congress has abdicated their control of money creation and limiting debt per the US Constitution and have given it over to a band of thieves. What was set in motion in 1913 will be the end of empire and the destruction of a nation.

    The following quotes are timeless, and apropos.

    “Fiat money eventually always goes back to its
    intrinsic value – zero” – Voltaire

    “Gold is money, all the rest is credit” – JP
    Morgan testifying in Congress in 1912

    “Permit me to issue and control the money of a nation,
    and I care not who makes its laws.” – Mayer Amschel Rothschild,
    International Banker

    “That is what our money system is. If there were no debts in
    our money system, there wouldn’t be any money.” – Marriner S. Eccles, Chairman
    and Governor of the Federal Reserve Board

    “I have had men watching you for a long time and I am
    convinced that you have used the funds of the bank to speculate in the
    breadstuffs of the country. When you won, you divided the profits amongst you,
    and when you lost, you charged it to the Bank. … You are a den of vipers and
    thieves.” – Andrew Jackson, 1834, on closing the Second Bank of the
    United States; (unabridged form, extended citation)

    “When a government is dependent upon bankers for money, they
    and not the leaders of the government control the situation, since the hand
    that gives is above the hand that takes. Money has no motherland; financiers
    are without patriotism and without decency; their sole object is gain.” – Napoleon
    Bonaparte

    “The issue which has swept down the centuries and which
    will have to be fought sooner or later is the people versus the banks.” –
    Lord Acton

    “And remember, where you have a concentration of power in a
    few hands, all too frequently men with the mentality of gangsters get control.
    History has proven that. All power corrupts; absolute power corrupts
    absolutely.” – Lord Acton

    “There is no means of avoiding
    the final collapse of a boom brought about by credit (debt) expansion. The
    alternative is only whether the crisis should come sooner as the result of a
    voluntary abandonment of further credit (debt) expansion, or later as a final
    and total catastrophe of the currency system involved.” – Ludwig von Mises

    “Money is a new form of slavery, and distinguishable from
    the old simply by the fact that it is impersonal, that there is no human
    relation between master and slave.” – Leo Tolstoy

    “You cannot spend your way out of recession or borrow your
    way out of debt.” – Daniel Hannan, Member of the European Parliament

    “The American Republic will endure until
    the day Congress discovers that it can bribe the public with the public’s
    money.” – Alexis de Tocqueville

  • MOLON LABE

    This a worldwide problem and here is another story from Cambodia.

    From Sex Workers to Human Trafficking: The High Cost of Cheap Clothes Oct 15, 2014

    Cambodia’s aggressive anti-trafficking campaign is designed to rescue and rehabilitate sex workers. But many women say authorities in Cambodia are actually forcing them into a trade where conditions and pay are even worse: making clothing for Western brands. VICE News traveled to Phnom Penh to speak with former and current sex workers, officials, and labor organizers to investigate what is happening to those swept up in the country’s trafficking crackdown.

    https://www.youtube.com/watch?v=rUHkW5mLxq8

  • EM

    Is there any evidence of govt purchases of equities through proxies? Are they open about this? Where can I learn more about this?