Central Banks Go Bonkers

This week, a certain joke became a painful reality.

Heaven and Hell

Heaven Is Where:     Hell is Where:
The French are the chefs     The British are the chefs
The Italians are the lovers     The Swiss are the lovers
The British are the police     The French are the mechanics
The Germans are the mechanics     The Italians make everything run on time
And the Swiss make everything run on time     And the Germans are the police

So that was the joke. Now here is the reality brought to you by a reshuffle at the European Central Bank:

Praet, 62, will be the first non-German to hold the role [of being in charge of the bank’s economics division] since the ECB was founded in 1998 and was a specialist in financial regulation at the Belgian central bank before joining the ECB’s Executive Board in June. Germany’s Joerg Asmussen will be responsible for international relations. France’s Benoit Coeure, another candidate for the economics job, will be in charge of market operations from March.

So we have an Italian in charge. A Belgian regulator running the economics division. A German in charge of international relations. And there’s a French henchman doing the dirty work. What a shambles. Perhaps even worse than Nero, Bonaparte and Hitler walking into an economic union.

Over at the US central bank, the Fed, things aren’t much better. Zerohedge.com reckons the annual rotation of voting committee members has left the inflationists in charge.

Here’s how it works.

The Federal Open Market Committee (FOMC), which sets interest rates, is made up of permanent members and rotating members. Of the rotating members, the outgoing ones are primarily ‘hawkish’, meaning they fear inflation. The incoming ones are ‘doveish’, meaning they fear deflation. That’s a simplification of their views, but it’s based on their voting records on interest rates. The hawks are more likely to favour higher rates to keep inflation in check. The doves prefer lower rates to prevent deflation. And when rates can’t go lower, the doves favour money printing.

The point you need to take away from all this is that the ECB just got even more dysfunctional. And the Fed just got uncomfortably functional. There will be far less resistance to central bank intervention in the US. And there will be confusion in Europe.

This is the opposite of what mainstream economists and financiers want. They want a stable market. That’s why central banks exist, after all. Financial markets need clarity in Europe and a steady hand in the US. It seems they will get neither over the next 12 months.

The Cacophony of Control

To free market believers, the idea that the composition of central bank boards should have such an impact on the global economy is disgusting. For all sorts of reasons.

For example, it’s supposed to be the central banks’ job to stabilise the economy. Stabilising inflation, unemployment and growth. Of course, it’s common sense that artificial and imposed stability has a habit of blowing up.

We’re not sure if it’s true, but there is a story about some biologists who set up the perfect environment for growing trees in a giant biosphere dome. They wanted to test how fast they could make the trees grow. After the experiment, the biosphere was removed and all the trees fell over. After a while, the biologists worked out it is the constant buffeting of wind that makes trees strong.

The world’s banks have been protected by their central banks for a long time now. Their ability to withstand the winds of economic life is compromised. Without central banks to keep them on the financial life support of incredibly low interest rates, banks would fail.

Looking closer to home, the Reserve Bank of Australia has been getting some stick too. A family friend visited during Christmas and let fly: ‘I reckon Glenn Stevens is a total … … How can he possibly know what the interest rate should be? And does he have any idea what sort of pain he causes when he increases rates? No, he lives in his ivory tower and just looks at data.’

This is just another problem with central planners. They set themselves up to be blamed for things that go wrong. That’s why so many of them end up as tyrants feeding off dependents. They have to suppress dissent. If people only had themselves to blame, then they might actually change their behaviour and stop blaming others (rightfully or not).

What is it about central bankers in particular that earns them a spot in today’s Weekend Markets and Money? Well, central bankers meddle with money. That means they meddle with the medium of exchange used in just about all transactions in our economy.

When government interferes in a particular part of the economy, most economists have no trouble spotting the problems they cause. Shortages, surpluses, barriers to entry, misallocation of resources and the rest. For some reason many free market believers think money is somehow different and that government meddling with money is a good thing.

Monetary Meddlomaniacs

Of course, they’re wrong. By instructing their central banks to target things like inflation, unemployment and growth, governments cause those very problems we just mentioned. Surpluses, shortages of money, barriers to entry, and poor lending decisions.

Let’s take a quick look at how those problems translate in to reality.

Ben Bernanke and Milton Friedman both studied the Great Depression and blamed its severity on the contraction of the money supply by the Federal Reserve. So that’s what a shortage of cash does. A surplus of cash gives you a 2001-2007 style boom. The fact that it was a gigantic bubble is how you know that it was a phoney surplus of cash and not a true economic boom. Another surplus or shortage caused by central bank meddling can be employment levels , such as the high unemployment during the Great Depression or artificially low unemployment during the boom years of a credit bubble.

Barriers to entry make it difficult to enter an industry. For drug companies this may include laws about having to test drugs very carefully before you selling them. In the world of finance, setting up a new bank is very hard, particularly when you are the opposite of a “too big to fail” – too small to be safe means depositors won’t like you very much. By being a lender and rescuer of last resort to big banks, the Fed makes life difficult for smaller ones.

Examples of misallocation of capital include subprime lending and the housing boom generally.

Central banks cause all this by interfering in the market of money and debt. Instead of allowing savers and borrowers of money to match up according to demand and supply, the central bankers predetermine the price – the interest rate – they think is ‘right’. They then step in to make up the surplus or shortage between the savers and borrowers at that price.

If they set the interest rate too high, there will be too many savers and not enough borrowers. An interest rate too low will bring too many borrowers and not enough savers. The central bank either pumps in or siphons off money to make up the difference.

Because the amount of borrowing is no longer matched by the amount of saving, the economy is fooled into making mistakes. Investments are made without the real savings to back them.

By accepting that manipulation always causes misallocation you begin to spot disasters in the making like the US housing bubble or the faltering Chinese economy. Just follow the manipulation and you fill find the misallocation.

If you think this kind of thing isn’t a (morbidly) amusing topic to think about, consider this typical example of disastrous government interference:

More than 2000 birds have died on Macquarie Island since the Australian federal government began a scheme to cull rabbits, cats, rats and mice.
The Federal Environment Department’s heritage and wildlife division told a Senate estimates hearing today that 2190 birds had died since the eradication program began last year.
Department officials said the birds had died after feeding off the corpses of poisoned animals and not from eating the pellets themselves.
“This is a complete debacle which just goes from bad to worse,” … “The collateral damage seems worse than the problem the government was seeking to eradicate.”

Do you trust this bunch to run your economy?

Until next week,

Nickolai Hubble.
Markets and Money Weekend Edition

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors. Founded in 1999, Markets and Money is published in 7 countries with a worldwide readership of almost 1 million people.

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2 Comments on "Central Banks Go Bonkers"

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“This is just another problem with central planners. They set themselves up to be blamed for things that go wrong. That’s why so many of them end up as tyrants feeding off dependents. They have to suppress dissent. If people only had themselves to blame, then they might actually change their behaviour and stop blaming others (rightfully or not).”

A very succinct and simple explanation of what’s wrong with the world today. It applies far more broadly than the economic landscape but also social implications of the ‘nanny’ state.

Great article.

Your example given at the end of your piece discussing bird deaths at Macquarie Island is poorly chosen, and i am sure that if you had taken the time to read even a small amount on the programmes aims you would not have included it. Given the early signs of the very significant environmental benefits emerging from the removal of rats and rabbits from this World Heritage site, I would suggest that based on your very flawed logic the response to the question you posed “Do you trust this bunch to run your economy?” – would be YES ABSOLUTELY!! I… Read more »
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