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How Central Banks Can Save The World
It’s Central Bank Week this week.
On Wednesday we get the next policy decision from The Federal Reserve. On Thursday the Bank of England and the ECB weigh in. And it’s possible that maybe the People’s Bank of China might jump in with a surprise… something they’ve done the last couple of times the BoE met.
But can they actually do anything to save the economy?
Saddled with debt and mindful of recalcitrant investors, nations in the developed world have lost their ability to solve their economic woes by adding more debt, leading them more than ever to rely upon central bank action. It is fantasy, however, to think that central banks can keep the game going for long. No central bank ever created anything tangible – you won’t find any stories about a Fed chairman discovering electricity or creating the light bulb. What central banks are best at creating is fiat currencies, and these are only as valuable as what they are backed by, whether it be gold, silver or the productive capability of a nation. Create or print too many of these and they will have no value to anyone, save for nerdy numismatists.
He then goes on to add…
Central bank liquidity can’t turn the lights on in Italy
The most irritating part of Crescenzi’s argument is actually the first line about how developed nations have lost their ability to spend more because of recalcitrant investors. The fact of the matter is that almost every developed nation (save for a minority of Eurozone countries) are seeing record low borrowing costs. Investors are CLAMORING for more government debt from the US, France, the UK, Japan, Germany, Sweden, Finland, Austria, Belgium, and so forth.
Across these countries, the main roadblock to more stimulus is political. In the UK, there was an active decision to cut spending by the Cameron government. In the US, the GOP has pushed hard against any more spending. In Europe, national politics more than the market have been the main constraint on government action.
All that being said, this idea that the world’s central banks are on the verge of blowing their credibility, and turning the the big currencies into toilet paper is silly and helpful.
In Europe, the ECB might not be able to make a lightbulb go on in Italy, but the ECB could definitely announce that it’s going to cap Italian bond yields (by, say, promising to buy any debt if 10-year yields got above a 300 basis point spread to German yields), thus instantly removing pressure on the government, and allowing the government to continue supporting the economy… so that the lights could stay on.
In Greece there have literally been threats that the power might go out due to lack of cash. The ECB could definitely play a role in letting Greece borrow money so that this wouldn’t happen.
Of course this creates other problems. In Europe, if the ECB started straight up funding governments it would create a moral hazard problem (all governments would want to spend as much as possible), and that would be very difficult to solve. Still, the immediate threat of the lights going out (or more realistically, a country leaving the Eurozone and redenominating the economy into a much weaker currency) would probably be taken off the table.
In the US, the Fed can also be helpful, though it’s not quite so straightforward.
People like to imagine Ben Bernanke printing cash like crazy, and dropping it via helicopter.
That’s why this is a popular image across anti-Fed, pro-gold sites.
The sad part is that what’s pictures above — Ben distributing Helicopter Money — would actually be very helpful. It would immediately help household balance sheets (say if a $ 10,000 bundle of bills were dropped on every house), it would create inflation (which is badly needed) and it wouldn’t add to the government debt, so it wouldn’t be so toxic politically.
But helicopter money is actually not possible.
There’s no free cash from the Fed. There’s only cash that gets swapped for bank assets, so the effect is more subtle.
BUT, if the Fed were to convince the private sector that it would let inflation run hot, then corporations (which are known to be sitting on prodigious cash piles) might feel they have no choice but to invest. And if nothing else, one effect of quantitative easing seems to have been pushing cash towards other private uses… i.e. holders of US Treasuries being forced into buying corporate debt, making it even cheaper for companies to borrow money, which presumably has some economic benefit.
Going back to Crescenzi above: It’s extremely popular these days to talk about the failures of those in power, and it’s nice and soundbity to say things like: You can’t solve a debt problem with more debt OR you can’t print your way to prosperity. It sounds good and tough to talk about the hard choices we have to make, and how prosperity only comes through someone tinkering away in a lab and creating a lightbulb that brings improved standard of living to the whole world.
And there’s truth to some of that, especially about innovation.
But that doesn’t man there isn’t a lot governments (either fiscal or monetary authorities) can do to improve things. A good place to start is for the world’s elites to stop being so vocally defeatist.