Jack Rasmus

Today the chairs of the world’s major central banks are meeting in Jackson Hole, Wyoming, to discuss their planned big changes in interest rates and QE policies that have injected more than $20 trillion into the coffers of bankers and investors since 2008. That massive injection of virtually free money for 9 years has produced a doubling and tripling of stock and bond markets and boosted capital gains income to unheard of levels in modern history. It produced tepid improvements in jobs and wage incomes, a weak economic recovery that is now about to end, and set the stage for the next financial crisis within the next 2-3 years.

What follows is an excerpt from my just published book, ‘Central Bankers at the End of Their Rope: Monetary Policy and the Coming Depression’, Clarity Press, July 2017, which documents how the Federal Reserve and other central banks have failed and have set the stage for the next crisis. (For more information on the book, go to the publisher, Claritypress.com/RasmusIII.html). Books may be purchased at discount from this blog and my website through Paypal.

EXCERPT FROM CHAPTER ONE:

Why Central Banks Are Failing

Central banks are failing because their ability to perform their primary tasks of lender of last resort, money supply management and bank supervision is in decline. The question then is what are the causes of that decline? What developments and forces in the global economy are disrupting central banks efforts to carry out their primary tasks? The following is a brief introductory overview of the key problems and fundamental contradictions with which central banks today are confronted.

a. Globalization and integration rendering central bank targets and tools ineffective

First, there’s the problem of the rapid globalization and integration of financial institutions and markets that emerged in the 1970s and 1980s which has grown ever since. Central banks are basically national economic institutions. The global financial system is beyond their mandate. Not only that, there is no single central bank capable of bailing out the global banking system during the next inevitable global financial crash. In 2008 it didn’t even happen. The US Federal Reserve and the Bank of England bailed out their respective banking systems, providing more than $10 trillion in direct liquidity injections, loans, guarantees, tax reductions and direct subsidies. The Federal Reserve even provided a loan in the form of a currency swap of $1 trillion to the European Central Bank and its affiliated national central banks. But the Euro banking system has not been effectively bailed out to this day. Nor has Japan’s. Together both have the equivalent of trillions of dollars in non-performing bank loans. Total liquidity injected into the private banking system by the world’s major central banks was in excess of $25 trillion. But non-performing bank loans today are also still more than $15 trillion. So much for the alleged ‘bailout’ of the banking system since 2008. While China’s banks and central bank, the Peoples Bank of China, was not involved in the 2008 banking crash and subsequent bailout, it almost certainly will be involved in the next financial crisis. In fact, China’s financial system may be at the center of it.

The fact that the financial-banking system today is highly integrated and globalized raises another problem for central banks. With today’s banking system composed not only of traditional commercial banks, but of shadow banks, hybrid shadow-commercial banks, non-bank companies engaging increasingly in financial investing, and financial institutions in various new forms serving capital markets in general, no national central bank’s operational tools or policies can control the global money supply or ensure stability in goods and services prices.

The global 21st century financial system is also well beyond the reach of central bank supervision. How does a single central bank supervise banks that operate simultaneously in scores of countries and economies? Or banks that operate solely on the internet, or with a formal headquarters located on some remote island nation? Massive sets of real time data are required for effective supervision by any single central bank. But access may be denied by national political boundaries, or significantly delayed and obscured by the same. To be able to bailout in the event of a crash, to effectively control the global money supply, or to reasonably supervise, national central banks would have to integrate and coordinate their policies and actions across their respective national economies. But they are far from being able to achieve such coordination at present, and in fact appear increasingly fragmented and going in different, and at times, even opposite directions. As the capitalist banking system becomes more complex, more integrated and more globalized, central banking has become less coordinated across national economies, not more.

Even the most influential central bank, the US Federal Reserve, is unable to globally coordinate national central bank actions with regard either to bailout, money supply management, or bank risk activity supervision. As of 2017, the Fed appears even more intent on going its separate way, independent of other major national central banks in Europe and Asia.

b. Technological changes generating instability

A second area of major problems is associated with technological change. Apart from technology enabling the rapid globalization and integration of finance, and the problems that has created for central banks, technology is also changing the very nature of money itself, creating new forms that are difficult to measure and monitor. A gap is also growing between forms of money and forms of credit. Money may be used to provide credit, but credit is increasingly made available without central bank and traditional forms of money. Credit is increasingly issued by banks (and non-banks) independent of money supply provision policies and goals of central banks. Hence, central banks are losing control over the creation of credit regardless of efforts to influence it through money supply manipulation. And credit means debt and debt is critical to instability.

Twenty-first century technology is also upending the manipulation of the supply of money by central banks as well. By various means, technology is accelerating the movement of money capital, speeding up the ‘velocity of money’ flow, both cross-borders and in and out of markets. Technology has also enabled fast trading, split micro-second arbitrage, and is contributing to an increasing frequency of ‘flash crashes’ in recent years, in both stock and bond markets, that are capable of precipitating broader financial instability and crashes. Technology also accelerates the contagion effect across markets and financial institutions when an instability event erupts. Not least, technology makes it possible for banks to avoid central bank general supervision. It is easier to hide data on a server in the internet cloud than it is to store paper records in filing cabinets away from central bank inspectors. Central banks, with relatively small numbers of supervision staff and inspectors, simply cannot compete with banks with technical staffs and leading edge technical knowledge.

c. Loss of control of money supply and declining effect of interest rates

Technology is broadening the very definition and meaning of money, beyond the scope of influence available to central banks’ via the traditional tools they have used to influence money supply. That is one reason why central banks since 2008 have been experimenting so aggressively (and even recklessly) inventing new tools, like quantitative easing (QE), to try desperately to reassert control and influence. But other forces minimizing central bank control over money are at work as well, among them the rise and expansion of shadow banking (see section d. to follow).

Another related source of loss of control is associated with non-bank multinational corporations, which invest on a global scale. Should the US central bank, the Fed, seek to reduce the national money supply by raising national interest rates, multinational corporations can and do simply borrow elsewhere in the world, ignoring US central bank’s efforts. They can even borrow in dollars offshore, since dollar markets exist in Europe, Asia and elsewhere as a consequence of the Federal Reserve having flooding the world with liquidity in dollars for more than a half century.

Since their earliest development in the ‘middle’ period of banking, central banks have attempted to stimulate (or discourage) real investment in construction, factories, mines, transport infrastructure, machinery, etc. by raising (or lowering) benchmark interest rates. Interest rates are simply the ‘price of using or borrowing money’. But the price of money—i.e. the interest rate—is not determined solely by the supply of money; it is also determined by the demand for money and by the velocity of money as well. Both supply and demand
determine price fundamentally. . But central banks have never had much, if any, influence over money determinants of interest rates. Money demand is determined by general economic conditions at large, not by central bank actions.

Furthermore, both the supply and the demand for money (and thus interest rates) are determined also by the velocity of money. The velocity of money, however, is increasingly determined by technology developments.
Both money demand and money velocity are drifting further from central banks’ influence. And to the extent they do so, central banks may be said to be steadily losing control over interest rates since interest rates are determined by all three: money supply, money demand, and money velocity. Central banks are left with trying to influence just one element—money supply—as a means to control interest rates, but their influence here is diminishing as well, as the globalization of financial markets accelerates and multinational companies grow,enabling access to a multitude of forms and sources of credit.

Central banks thus have decreasing influence over even the money supply determinants of interest rates, let alone influence over both money demand and the velocity of money which are equally important determinants of rates. Central banks are steadily losing control of their key operational lever, the interest rate, as the means by which to influence economic activity. As will be addressed in subsequent chapters, this general fact is perhaps why central banks have abandoned the manipulation of interest rates as the means by which they
attempt to influence real economic activity in a given economy.

d. The rise and expansion of shadow banking

Shadow banks constitute a particular problem for central banks along a number of fronts. Shadow banks engage in high risk/high return investing and are thus often at the center of financial crises requiring central bank bailout. Shadow banks exacerbate the decline in central banks’ ability to determine money supply and in turn interest rates. And shadow banks are mostly beyond the scope of central banks’ supervisory activities, although some very minimal central bank supervision has been extended to some segments of the shadow banking world (e.g. mutual funds in the US) since 2008.

A body of academic and central bank literature has developed since 2008 on whether and how central banks (and governments in general) should increase their regulation of shadow banks. Standard financial regulation legislation and agencies’ rules address financial regulation of traditional banks. The new area addressing shadow banks is sometimes referred to as Macroprudential Regulation. But to quote Rubin—a former shadow banker himself—once again, central banks today are still light years away from being able to regulate the
shadow banking world. This is because “no one comes close to having identified the full reach of shadow banking or the systemic risks it poses”, which “would be a monumental undertaking for the United States alone” but “it becomes even more daunting once shadow banking outside of our borders is considered.”

As this writer has previously concluded, thinking that central banks can macro-prudentially regulate or effectively supervise shadow banks—given the magnitude and global scope of operations and growing political influence of shadow banking—is delusional. “Technology, geographic coordination requirements, opacity, bureaucracy, the massive money corruption of lobbying and elections by financial institutions, fragmented regulatory responsibilities, the sorry track record to date of Fed and other agencies’ regulatory efforts, and the multiple interlocking ties involving credit and debt between private banking forms—all point to the futility of regulating shadow banks in the reasonably near future.”

e. The magnitude and frequency of financial asset price bubbles

Central banks are failing to prevent or contain financial asset price bubbles. This particular failure is not just that they lack the tools, but that they lack the will to do so. This is in part political. There’s a lot of money to be made by capitalist investors and institutions when financial bubbles are growing. To intervene when the financial elite is ‘making money’ is to court the ire and intervention in turn by government supporters, political friends, and the corporate media.

As the former head of a major US bank during the 2008-09 crash, Charlie Prince, admitted when interviewed after the crash and asked did he not know the banking system was headed for financial Armageddon? Why did he not stop the excessive and risky investing practices at the time? Prince simply replied, ‘when you come to the dance, you have to dance’. What he meant was he (and likely other banker CEOs) knew the system was headed for a crash. But he couldn’t buck the trend without his shareholders, demanding to participate with other banks in the great profits and returns from the risky speculation in subprime bonds and derivatives. If Prince had swum against the tide, he undoubtedly would have been sacked by his Board and shareholders.

A similar powerful opposition would likely have descended on the Federal Reserve officials at the time in 2007-08, had they acted to ‘prick the asset bubble’ before it burst. But burst it did, causing trillions of dollars in bailouts in its wake. Central banks would rather try to clean up the mess from a bubble and crash than try to prevent it, or even slow it down. They and supporters in the media and academia therefore raise excuses and arguments justifying their non-intervention to prevent destabilizing financial asset price bubbles.

The main arguments include it is not possible to determine whether a bubble is in progress or not, until after the fact. Or it is too difficult to know if it’s a de facto bubble or just a normal financial market price escalation.Or, to deflate a financial bubble in progress is likely to set off a financial panic prematurely, and thus provoke the very condition that it was supposed to prevent. Or, central banks’ monetary tools aren’t designed to stop excessive asset price inflation in any event. Nor is responding to asset price bubbles part of the ‘mission’ of central banking. The mission is to prevent excessive price instability in real goods and services; to stabilize the price of money (e.g. interest rates), or maybe even to modestly encourage wage (factor prices) growth in order to support their mission of encouraging economic growth and employment (through consumption). But ‘hands off’ preventing on financial asset inflation or instability. Without saying it in such direct terms, what is meant is regulating financial asset prices and preventing bubbles is de facto directly regulating the rate of profit realization from financial asset market capital gains!

Nearly fifteen years ago, when just a member of the board of governors of the US Federal Reserve, for example, Ben Bernanke addressed in a formal speech the subject of financial asset bubbles intervention. He made it clear, leaving no doubt as to the policy of the central bank at the time, that it was neither desirable nor
possible to intervene to prevent financial asset bubbles. All a central bank was mandated to do was set a target for inflation, by which he meant a target for inflation in goods and services prices, not financial asset prices. Stabilizing goods prices would eventually stabilize financial asset prices in turn, it was assumed. But: to quote Bernanke at the time, before he was made chair of the US central bank in 2006, “an aggressive inflation-targeting rule [say 2% ?] stabilizes output and inflation when asset prices are volatile, whether the volatility is due to bubbles or to technological shocks…there is no significant additional benefit to responding to asset prices.” Years later, in 2012, as Federal Reserve chair, well after the crash of 2008-09, Bernanke held to the same view: “policy should not respond to changes in asset prices…trying to stabilize asset prices per se is problematic for a variety of reasons”…and it runs the “risk that a bubble, once ‘pricked’, can easily degenerate into a panic.”

What this mistaken view represents, however, is a denial that asset price bubbles are always followed by asset price bust and deflation, and that collapsing asset prices can and do have significant negative effects on the real economy and therefore on production, unemployment, decline in consumer spending and on prices of goods and services. The Bernanke view was simply wrong. But it served as a logical economic justification to not address financial price bubbles. And not a word about how monetary policies depressing interest rates for years, might cause central bank-provided liquidity to flow into financial asset markets and create the very bubbles that, according to Bernanke, the Fed and central banks should do nothing about!

Since Japan’s early financial crash in 1990-91, and its subsequent banking crash in 1997, scores and perhaps hundreds of academic journal articles and books have been written on the futility of doing anything about financial bubbles. Most echo the same logic: just target reasonable inflation for real goods and services and the rest will take care of itself. This traditional central bank view refusing to address financial bubbles continues to this day.

f. The growing political power of the global finance capital elite

Central banks both facilitate and are confronted with the rising political influence and power of the new global finance capital elite. The elite constitute the human agency driving the restructuring of the global economy in the 21st century that is responsible for creating most of the problems and contradictions confronting central banking today. Symptoms of their political influence include the successful deregulation of financial activities by governments, their corralling of an accelerating share of income and financial wealth from financial investing and speculation, and the absence of any prosecution and incarceration of their members when their practices precipitate financial crashes and their disastrous consequences on the public at large. Central banks have been unable thus far to ‘tame’ this new, aggressive, and ultimately destabilizing form of capitalist investment.