From independence, freedom and truth


Dangerous monetary policies

Fernando del Pino Calvo Sotelo

September 8, 2012

In my previous article “The Myth of the Central Banker” I tried to demystify central bankers on the grounds of their very mediocre forecasting track records and analyses of reality. Their decisions are too often influenced by the dynamics of power and public image, the short-termism linked to political cycles and the most primitive of panics, when the storm breaks. But the strongest bias of all is the illusion of control, by which human beings tend to overvalue their own capacity to control their environment and their destiny. In my view, the complexities of this ecosystem called The Economy are such that the pretension of controlling and influencing it with the precision you drive your car is arrogant and delusional. Thus, when trying to do so, we fall prey, time and again, to the perennial Law of Unintended Consequences. Trapped in this illusion of control and the arrogance of power, the monetary policies of Western central bankers, particularly the Federal Reserve, have created the credit orgy that now engulfs us.

Are we to believe that those who caused the crisis are the ones capable of solving it? We have already commented on the inability of central bankers to forestall events or to reliably interpret the economic reality. They justified and legitimized the most extravagant excesses and turned a deaf ear to those who watched with concern the gathering storm. The deceitful slogan “no one saw it coming” was fabricated to cover the nakedness of those who thought of themselves as infallible. What do these same people propose now? Disregarding the artificial complexity used to intimidate the critics, their only solution is to create money out of thin air, to print money in order to repay the inordinate amounts of debt we owe. The idea is neither new nor brilliant. In fact, the temptation to print money is very old historically and has proved to be almost irresistible, becoming the politicians’ favorite way to kick the can down the road when debts become unsustainable. In times before the invention of paper money, coins would be debased reducing the content of precious metal; such was the case of the Roman denarii. In the 9th century, Chinese Emperor Hien Tsung used paper currency for the first time in order to overcome a copper shortage. The experiment worked for three centuries until inflation convinced the Chinese to move onto silver, which they would continue to use until the 20th century. Desperate governments, overwhelmed by events, slaves to their own spendthrift pasts and the unbearable weight of out-of-control debts have resorted to this easy solution since time immemorial. It is the usual final chapter of a sovereign debt crisis and, in the long term, has never ended well. To pretend that this time it is different is laughable.

In a paper published by the Dallas Federal Reserve this August, William White argues that ultra-easy monetary policies “can eventually (!) threaten the health of financial institutions, the functioning of financial markets, threaten the “independence” of central banks, and can encourage imprudent behavior on the part of governments”. Remarkably, he does not mention the word inflation but, nevertheless, with all these secondary effects, how can this drug be prescribed so frivolously?

In my previous article I mentioned several paradigmatic central bankers with the aim of showing their serious errors of judgment. But decision analysis must turn a blind eye to the strengths and weaknesses of the decision maker and focus instead on the decision making process. Is there really any chance we can make monetary policy more objective detaching it from the weaknesses of the decision maker? For some years, the Federal Reserve and other central banks have flirted with the idea of having an automated monetary policy using models such as the Taylor Rule, which is supposed to determine the optimum interest rate level. However, our central bankers have soon felt uncomfortable with such restrictions: unlimited power, completely discretionary, is always more attractive. In fact, John Taylor himself has shown his concern for the borderless discretion with which the Federal Reserve seems to operate nowadays. He explained it in a simple book whose attractive subtitle read: “How government actions and interventions have caused, prolonged and worsened the financial crisis” (Amen). It is difficult to exaggerate the level of interventionism performed by central banks riding roughshod over their mandates.

Each country bears its own historic economic traumas, and individual monetary policies undoubtedly reflect them. In the US the trauma is the Great Depression and the stock market crash of 1929, when the Dow Jones index fell by 90% and took 25 years – a whole lifetime – to recover. In Germany, however, the trauma is the hyperinflation suffered in the Weimar Republic, which devastated the country. Bernanke and his gang believe that all problems are solved through printing more money.  Germany’s Bundesbank, on the contrary, believes that all problems spring from printing too much money. Two opposite visions destined to collide and further intertwined by their different mandates.

In the US, the Federal Reserve has a double mandate: price stability and maximum employment (Bernanke, I have to add, has invented a third mandate: making sure the stock market does not come down). The second part of the mandate was introduced in 1977, when socialist interventionism was in vogue and permeated legislations everywhere (the 1978 Spanish Constitution being a perfect example). This double mandate has been the perfect excuse to make ever broader and abusive interpretations of it.

In Europe, the European Central Bank only has a price stability mandate, but who cares? In this Europe of the euro there is no rule of law: no mandate, law or treaty stands in the way of a euro-fundamentalist in panic. A clear example is how the ECB performs miracles by buying troubled countries’ debt, either directly or indirectly, or accepts as collateral overvalued, low quality assets.

Western central bankers are running a massive experiment with our money. They have multiplied the size of their balance sheets, filled them with toxic assets and kept a totally artificial interest rate policy. Thus, they have destroyed the concept of a risk-free asset and consequently wiped out the pillars of asset valuation. A problem of excessive debt caused by interest rates set too low for too long cannot be solved by ever lower interest rates and ever growing levels of debt. Addictions are not healed increasing the doses, but going through the pain of withdrawal.

Ludwig von Mises wrote that “the task of economics is to foretell the remoter effects (of a measure), and so to allow us to avoid such acts as attempt to remedy a present ill by sowing the seeds of a much greater ill for the future”. Our central bankers are proving they are not living up to that task.

First we became addicted to debt. Now we are becoming addicted to printing money. If we don’t change course, History says that this will end up as a disaster, so we must stop kicking the can down the road before it’s too late. Postponing the inevitable has become a very dangerous game.


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