From independence, freedom and truth


Destructive monetary policies

Fernando del Pino Calvo Sotelo

October 21, 2016

We are living in an era of economies intervened by central bankers who have been raised to the level of magicians or even gods of Olympus: infallible, clairvoyant and beneficent. Unfortunately nobody whispers in their ear, while holding up the laurel crown, that they are nothing but men. To be fair, at the worst moment of the crisis central banks acted correctly in their role as lenders of last resort and stabilized the financial system (mark-to-market suspension also played a key role). The problem is that it appears that, once having savored the sweet smell of the power they were temporarily given, they have become addicted and do not wish to suffer the withdrawal. Thus we find ourselves eight years later in a very different reality in which, with huge temerity, the world’s largest central banks (the Federal Reserve, the European Central Bank, the Bank of Japan) are conducting a extremely dangerous and unprecedented monetary experiment, placing us in a dead end from which, by definition, they neither know how to exit nor are capable of so doing. The philosophy behind this is very familiar and has always been advocated by interventionism: a limited, self-defined élite plays God in the belief that it can control the economy, missing the little detail that an economy is no machine but rather an ecosystem made of human beings endowed with intelligence and free will who, rather than complying with the élite’s instructions, will act as they feel best. Empirical evidence confirms that interventionism doesn’t work, but interventionists have never allowed this stubborn reality to spoil their pretty fantasy of power. What does work is that wonderful spontaneous order known as free market, which respects man’s freedom, dignity and responsibility, leads man to develop his best talents, and has proven to be enormously efficient in pulling up a large section of humanity from poverty. As we know since biblical days, all economies are subject to cycles in which prosperity alternates with hardship, cycles born out of an inevitable and immutable fact: man is fallible. In a vain chase for that impossible fantasy called the non-cyclical economy (that permanent plateau), interventionism creates perverse incentive systems that do away with the therapeutic nature of recessions, painful but nonetheless healthy and indispensable for cleaning and correcting the errors and excesses of the past. Needless to say, what motivates politicians in their futile attempt to avoid the down-cycles is not the citizenry’s welfare, but rather their anxiety to ensure that lean times do not coincide with reelection times – always an uncomfortable coincidence. Interventionists repeatedly ignore that one may lead a horse to water, but cannot force it to drink. Indeed, interventionism may force a businessman to set a maximum price on a product or minimum wages for employees, but cannot force him to produce at such prices if that means losing money and going bankrupt as much as he cannot be forced to hire new employees if the salary level set by the nomenklatura is higher than the employee’s productivity, because the result will be the same. Interventionists may set confiscatory tax rates or mandate regulations which approach sadism, but they can neither force the employer to accept doing business in such conditions, nor stop him from sailing off to another location where there will be no such constant torture applied for the heinous crime of trying to create wealth for himself, his family and his community.

Likewise, central bank interventionists may set zero interest rates and create oceans of liquidity out of thin air (I never understood why they deserved credit for such a simple action), but they cannot force banks to lend to borrowers they deem inappropriate, or to lend above the level recommended by prudent risk management practices, just as they cannot force citizens or businesses to borrow if they do not need to do so or cannot afford it, or if they consider it would entail an unnecessary risk. The Western world faces a major problem called excessive debt. Spain’s non-financial private debt was 90% of GDP in 1999 and is now ca. 170% of GDP. Public debt was below 60% of GDP in 1999 and is at present above 100% of GDP, and growing. Does it make sense to provide incentives to increase indebtedness at a time of excessive debt? Also, there are numerous studies that show that high levels of debt encumber economic growth. Do we wish to have lower economic growth rates in the future? If the problems we are currently facing are really serious, what kind of problems can we expect to face in the future with more debt and less growth?

Central banks now assert they wish to create inflation in spite of the fact that there is not one single precedent in History of successful creation of controlled inflation. To this end they have gone as far as to create negative interest rates, an unprecedented concept in the 5,000 years of documented history of humanity. Interest rates simply reflect that a good or a dollar today, certain, safe, touchable, is worth more than a virtual, uncertain good or dollar in the future. As the proverb says, a bird in the hand is worth two in the bush.  However, at present 10 trillion euros in sovereign debt and 300 billion in corporate debt bear negative interest rates, that is: the lender pays the borrower for the privilege of making the loan. Imagine a mortgage in which the bank not only lends you the money but also makes monthly payments to you as a present for allowing him to lend to you (is that an asset or a liability?). Maybe it is because I am not a central banker that I believe this to be an aberration or, if you will allow me, a lunacy.

Of course, these zero and negative interest rates have caused the largest bond bubble in History and a new bubble in stock markets. The history of finance shows that all bubbles, without exception, eventually burst, as happened in 2008 with the real estate and stock market bubbles. Perhaps when the current bubble created by the temerity and arrogance of central banks bursts, 2008 may seem to be a walk in the park.

Interest rates are also prices (of money) and, as such, they are a mechanism for the transmission of information (regarding the uncertainty of the future, the expectation of inflation and growth or the credibility of the debtor). This mechanism of transmission of information is indispensable for the correct functioning of the economy and central Banks have destroyed it. For example, as a result of the intervention of the ECB, European sovereign bonds (including those issued by Spain, Italy and even Portugal until a few months ago) have lower yields than US or Canadian government bonds, which is not only a distortion and an artificial price level worthy of La-la Land, but is also something that demotivates our politicians (who are already far too prone to relax) from promoting the badly needed truly structural reforms.

Finally, these monetary policies are endangering banks, insurance companies, retirees and pension funds who depended on a reasonable yield of their fixed income and on a positive yield curve, leading them to take imprudent risks in sheer desperation. Let’s not forget that as night follows day, bankruptcies follow imprudent risks.

It doesn’t seem to be a good idea that supposedly developed democracies contain institutions holding such immense power (in spite of their deplorable forecasting track record), are de facto free of any legal constraints, answer to no one and are subject to no control whatsoever, and have unelected leaders who have no skin in the game and are totally exempt from all responsibility for their actions. Such a system virtually guarantees abuse of power and huge trouble ahead.

When I was a student I was taught that central banks that printed money and bought public debt with that money belonged in banana republics and ultimately destroyed their currency or their countries. Central banks have by now turned many developed countries into banana republics, and we shall have to face the consequences. These will doubtless be negative, but I fear there is a possibility that they might be disastrous to the extent of putting the whole system at risk.


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