When Central Bankers Attack: Why Ben and Company Can’t Save the Global Economy

New action by central banks around the world has cheered markets, but the boost will only be temporary

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FREDRIK€ VON€ ERICHSEN / DPA / LANDOV

Greek Prime Minister Antonis Samaras, left, and European Central Bank President Mario Draghi greet each other in the foyer of the ECB in Frankfurt on Sept. 11, 2012

With the global economy still struggling to emerge from the Great Recession, the world’s central bankers have stepped in yet again in an attempt to spur growth and strengthen the recovery. In mid-September, the Federal Reserve announced it would extend its bond-buying program to bring down long-term interest rates and stimulate investment and employment. Federal Reserve Chairman Ben Bernanke said the effort, being called QE3, will “employ our policy tools as appropriate” until the U.S. finally sees a jobs recovery. In Europe a few days before, European Central Bank (ECB) President Mario Draghi inserted himself to ease the euro zone’s debt crisis. He announced a potentially unlimited program to buy one- to three-year sovereign bonds from debt-burdened euro-zone governments that agree to an E.U. budget-cutting conditionality program. Draghi called the program “a fully effective backstop to avoid destructive scenarios” for the monetary union. In Japan, the central bank surprised markets and followed the Fed by expanding its asset-purchasing scheme to boost a sagging Japanese economy. “The [Bank of Japan] deemed it necessary to act so that Japan’s economy will not be derailed from a track toward sustainable growth,” bank governor Masaaki Shirakawa said.

Give Ben, Mario and Masaaki credit where it is due: at least they are trying to do something to help the global economy. Markets have cheered their perseverance. Stocks in the U.S. have rallied on Bernanke’s new policy. “Super Mario” Draghi has (yet again) pulled the euro zone back from the brink of disaster. Yields on the bonds issued by the Spanish and Italian governments have plunged, easing the crisis.

Yet this good feeling is unlikely to last for very long. The reality is that central banks cannot on their own solve the problems of the world economy — stamp out unemployment, restore healthy growth or rescue the euro — with the tools available in their toolbox. Not even the bankers themselves believe they can. Bernanke himself admitted that the Fed lacks “tools that are strong enough to solve the unemployment problem.” In Europe, the difficulties facing the monetary union are so deep that Draghi can do little more than smooth them over, not actually resolve them. As Martin Wolf put it:

It is not the ECB’s fault that this action is too little. Its aim is to eliminate the risk of a euro-zone breakup forced by the markets. But it cannot achieve this on its own. Ensuring the survival of the euro zone is a political decision. The ECB can only influence, not determine, the outcome.

Let’s face it — there is just a limit to what monetary policy can do. Easier money from the Fed is not going to reboot the U.S. housing market or convince companies to hire workers they don’t feel they need. That’s because monetary policy works indirectly — by easing, the Fed hopes to make it even cheaper for companies to invest, but that doesn’t mean they will, or that they will hire a lot more people as part of any new investment. Even within the financial sector, which benefits most directly from loose monetary policy, jobs are not being created. Bank of America and other financial institutions have been shedding employees. To truly ensure growth and job creation in the U.S. economy, Bernanke needs help from Washington, in the form of a coherent strategy for reducing the national budget deficit, tax reform and a plan to build better infrastructure and take other steps to bolster American competitiveness. But with American politicians paralyzed by partisanship and locked in electoral battles, no congressional cavalry is likely to appear on the horizon.

Draghi is in a similar position in Europe. A bond-buying program by the ECB can improve market sentiment but it can’t repair the structural problems of the euro zone or fix the finances of member governments. Ensuring the euro’s survival will require tighter coordination of fiscal and banking policies across the euro zone, a real growth strategy, and continued austerity and reform measures on the part of individual governments. Though yields on the bonds of troubled companies have come down since Draghi’s pledge, the underlying conditions in the euro zone have not significantly improved. Greece’s exit from the monetary union is still a real possibility as its government struggles to fulfill budget cuts and other reforms imposed by its neighbors as part of an E.U.-sponsored bailout. Floundering Spain may be moving closer to seeking an E.U. bailout as well. And even as Draghi touted his bond program, he also lowered the ECB’s outlook for the euro-zone economy. The central bank now expects euro-zone GDP to contract by as much as 0.6% in 2012.

Japan’s excruciating experience can tell us a lot about the limitations of central-bank action. The round of easing announced in September by the Bank of Japan is just the latest in a long series of such attempts to stimulate growth since the late 1990s. And where has it all gotten Japan? Not very far. The economy continues to slip in and out of recession. That’s because its politicians have generally failed to undertake the types of reforms — building a better social safety net, bringing down trade barriers and liberalizing the domestic economy — needed to truly return the economy to health.

Even more, central banks are taking on quite a bit of risk by their recent actions. Brazil’s finance chief warned that easing by the world’s major central banks could tip off a “currency war” — a contest to weaken their currencies to spur exports with worldwide consequences. By attempting to aid the balance sheets of European governments, the ECB is potentially creating a hole in its own balance sheet. In an editorial, the Financial Times made that clear:

Mr. Draghi may claim that the ECB will stop buying the bonds of countries which are not compliant with their agreed programs. But doing so after the central bank has stuffed itself with a country’s bonds is like putting a gun to one’s own head and threatening to pull the trigger.

My own opinion is that Ben, Mario and their colleagues have done enough to help the global economy, and that these latest measures are simply cover for a lack of concerted action on the part of politicians in the developed world. Perhaps our central-bank chiefs have again bought us more time. Let’s hope our elected leaders finally take advantage of it. 

6 comments
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bcfred
bcfred

The idea that lower interest rates will spur anything at this point is laughable.  We have been at historical lows for nearly four years.  It's not the cost of borrowing that's limiting investment, it's the utter lack of visibility into returns on that investment.  Companies aren't going to borrow if they are worried about paying the money back, regardless of interest rate.  Meanwhile the cost of QU3 is the Fed taking ever-greater risk buying up bonds that will swing widely in value when market rates do start to increase.  As for the political class, the best it can do it foster an environment where private businesses can thrive.  If governments could create jobs then collectivism would be the dominant economic system on the planet.

josephmateus
josephmateus

The Fed is not taking any risk at all buying up risky bonds, because it simply creates the money out of nothing to buy these junk mortgage bonds. So if market interest rates rise, the value of those bonds goes down alright, but because the Fed didn't actually buy those bonds in the sense that one has to spend its limited amount of money to buy something, it has nothing to lose. On the contrary, us we the consumers are the ones who have much to lose with this unlimited creation of new money out of thin air.

It goes like this: > Helicopter Ben Bernanke creates 40 billions brand new dollars every month out of nothing, with absolutely nothing to back them up because the US government is bankrupt. Instead of all this new fiat money going to us, the consumers, instead ends up in the hands of investment bankers in Wall Street, and some of it goes to the US Treasury Department in order to pay the interest in the ever growing federal debt. Still, some of it ends up in the hands of big corporations. But the corporations horde the money and do not use it to expand and creates jobs, because there is no demand for their products and services. 

Deleveraging continues big time as consumers try to pay off over 15 trillion  in accumulated debts. (See the US National Debt Clock - http://www.usdebtclock.org/ at the bottom, under "Personal Debt"). They are not buying, thus there is no demand. And this investment banks, instead of lending to businesses to expand and create jobs, turn around and go and buy natural resource and commodities stocks in the market. This bids up the price of food commodities and natural resource commodities, such as oil, gold, silver, etc.

Now as the price of oil increases in the stock market so does the barrel of oil, which in turn makes gasoline more expensive as well as a myriad of other products that depend on oil for its mobility. The price of wheat, coffee, sugar, soy, etc goes up as their stocks rise in price at the stock market.

Now the consumer, already squeezed by high unemployment and under employment, with reduced wages in order to keep his/her job, finds it harder and harder to buy food and other essentials, further making them cut back even more, further reducing demand for goods and services. It is just a big insidious vicious cycle that feeds on itself like a dog chasing its tail.

Now as all this natural resource commodities are all priced in dollars in all the international markets, as their price goes up, the more dollars it takes to buy the same amount of product, and this is how currency devaluation occurs. The Keynesian's don't like this word, but it is simply called inflation.

There is simply no way on this earth that Helicopter Ben Bernanke can continue to create more than a billion dollars a day out of thin air and not have to suffer the consequences of rapid inflation through currency devaluation.

If anybody tells you that the US Fed can create 40 billion new fiat dollars a month out of nothing until the cows come home on a hot summer night (This new QE3) and this will not create rapid inflation, they are not living in the real world. They need to come down from cloud 29, wake up from their most preposterous Snow White and the Seven Dwarfs Pollyanna world, give their thick heads a good shake, smell the coffee, smarten up and get on the ball.

gracetoday
gracetoday

What encourages investment is the assurance of return so they can make even more money. think about it, if someone gives you a million dollars and then encourages you to invest it, you won`t invest it unless you think you can turn that million into more millions. If you don`t think the markets are condussive to growth, you won`t invest even if I give you a billion. Investors today don`t trust the system. If the fed wants to stimulate growth, they need to stop throwing money everywhere and show investors that they are serious about solving their debt issues. The states are the lenders of last resort. But when the lenders of last resort are approaching bankruptcy, then there is no safety in the markets. 

Talendria
Talendria

I think there's only so much the government can do to solve these problems at the macro level whether economically or politically.  We the people need to start doing our part at the micro level.  We need to use our purchasing power more wisely, investing in local businesses as much as possible and maintaining enough in savings that we can weather a financial crisis without losing everything.  We need to make ourselves the kind of employee that no organization can do without:  always on time, always enthusiastic, quick to solve problems.  Most employees today are such a pain in the ass that organizations would rather downsize to maximize profits than expand to maximize sales because they simply can't hire enough quality workers.  The politicians need to start doing their jobs, but we need to do ours also.

quantweb
quantweb

Hi

Euro: Optimal Currency Area, theory and

current situation is the fifth video of the Fun amp; Finance´s Second Season.

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In this episode, along with Marco Biagetti

from Rome, we talk about the Euro Zone; topics such as what is an optimum

currency area and what are the ECB´s current actions.

Together with this video, we made another

with a bonus question about the current situation in Italy and Spain.

https://vimeo.com/49952854

thank you for watching our

videos