Financial crisis: the printing press has reached its limits

Faith in central banks has been shaken to the breaking point by the events of the financial crisis. Even five years after the crisis began, monetary policy is still struggling to deliver meaningful solutions and government spending has failed to revive the economy as hoped.

By Jeremy Warner
8:33PM BST 30 Aug 2012
The Telegraph

Few jamborees excite financial markets as much as the symposium of international central bankers which is held annually in late August at Jackson Hole in the Rockies.

Interest this year focuses around whether, with the American recovery again running out of steam, the US Federal Reserve is about to signal a further round of quantitative easing, marking the third such burst of money-printing in that country since the crisis began.

Yet it is also fair to say that the gathering no longer holds quite the same cachet it used to. Faith in central banks as guarantors of macro-economic stability has been shaken to breaking point by the events of recent years, a crisis which they utterly failed to see coming, still less were able to prevent.

The symposium has been further devalued by the fact that many of the top European central bankers, including Mario Draghi, president of the European Central Bank, are still so busy fire-fighting that they have failed to show up.

If nothing else, the event serves to highlight that five years after the crisis began, monetary policy is still struggling to deliver meaningful solutions. Here in the UK, the Government has put its faith in a combination of “fiscal conservatism and monetary activism” to lift the economy out of its funk. In the event, government spending has hardly been checked at all, while monetary activism has failed to revive the economy as hoped. Output remains firmly stuck a full 4.3 per cent below its pre-crisis peak.

Central banks stand widely accused of having failed. Is this fair? Not entirely. Just as they were much too highly rated before the crisis hit, they have now become somewhat oversold. Part of what went wrong in public policy in the lead-up to the credit crunch is that too much trust was vested in central banks, which were widely credited with almost superhuman powers. This led to a feeling of false security and a blissful disregard of what the bankers, the politicians and the wider economy were up to. Whatever happened, it was thought, monetary policy could always be relied on to come riding to the rescue. In the US, they even had a term for it – the “Greenspan put”, after the former Fed chairman Alan Greenspan.

Mr Greenspan enthusiastically played up to his role as one of the immortals, with such Delphic-like observations such as: “I know you think you understand what you thought I said, but I’m not sure you realise that what you heard is not what I meant.” At the time, this remark was thought a sign of great wisdom. Today, it just looks idiotic.

If the crisis has taught us anything, it is that it is unwise to place too much faith in central banks. The most they can hope to do is paper over the cracks. In this regard, they have so far proved relatively successful, with the possible exception of the dysfunctional European Central Bank, so torn apart by national differences that it can scarcely be regarded as a proper central bank at all.

Again with the possible exception of the eurozone, the mistakes of the 1930s, when failure to counter a violent contraction in money and credit led to cascading bankruptcies and mass unemployment, have generally been avoided.

Yet there is still a lingering belief that central banks could and should be doing more. This stems from the idea that the root of the problem in advanced economies is merely one of confidence and demand. If this is true, then the task of reviving growth should be relatively straightforward. If ways could be found of getting the money flowing again, by persuading households and businesses to spend rather than save, all would be well. It follows that central banks should keep on pushing interest rates deep into negative territory until they get a result.

Unfortunately, it’s not working. Money-printing may have prevented much worse outcomes, but it doesn’t seem to have got demand growing again. All kinds of bonkers ideas have been suggested for going further. Why not give consumers the money to spend instead, or simply cancel the £375 billion of government debt the Bank of England has bought through quantitative easing? Or maybe the Government could stop borrowing altogether, and simply monetise the deficit?

It scarcely needs saying that this is what happened in Weimar Germany. It would also be illegal under the Lisbon Treaty. Permanent expansion of the money supply, with no means of withdrawing the cash once the economy picks up again, would lead to a run on the pound, hyperinflation and, eventually, sky-high interest rates.

In any case, if demand is not responding to QE, then the problem may not be one of demand at all. There is, regrettably, a much more uncomfortable conclusion to be drawn. In a recent article, Raghuram Rajan, a former chief economist at the IMF, articulated what I have long found the most compelling way of looking at the economic crisis. For decades, he wrote, advanced economies were losing their ability to grow by making useful things. But they needed to somehow replace the jobs that had been lost to technology and foreign competition, and to pay for vote-winning entitlements. So to pump up growth, governments spent more than they could afford and promoted easy credit to get households to do the same.

Predictably, this proved unsustainable. Without politically painful supply-side reform to correct these failings, we can look forward to years of stagnation or worse. Central banks may have succeeded in preventing a repeat of the Great Depression, but they cannot correct these underlying deficiencies. To think they can somehow magic away all our problems is to descend into the fantasies of the past.

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