This is the time of year when we all get some time to listen to various pundits carefully dissect some bland words spoken by a central banker at Jackson Hole. It is a given in all financial circles that everything said by Janet Yellen, Mark Carney or Mario Draghi is very, very important. But should it be? Should this tiny group of unelected economists be so powerful?
Perhaps not. Look back to the financial crisis. Our central bankers played a large part in causing it in the first place (creating inadequate regulation and keeping interest rates far too low for far too long). We knew this even in 2007: not many people could say exactly how the financial crisis would unfold, but there were a huge number of voices pointing out that low rates lead to credit bubbles and to inevitable crisis. All those voices were firmly ignored by the world’s central banks.
Yet when those same central bankers insisted they were the only ones who could ride to the world’s rescue after the crisis, governments believed them. Hence quantitative easing (QE) and some of the lowest interest rates in history – things which, while they might have sounded impressive at the time, have definitely not worn well. The original idea behind QE, as described by the Bank of England in 2011, was to print money, buy things with it and so “push up asset prices and stimulate expenditure by lowering borrowing costs and increasing wealth”.
That is exactly what has happened, just not in a good way. Almost all global stockmarkets are now expensive. This is partly for demand reasons: cheap money makes big companies look more profitable; it cuts the cost of their debt and encourages the mergers and acquisitions that boost their market power and hence their margins. That, alongside the fact that with interest rates so low investors will buy anything for even the tiniest of dividend yields, has made equities look very attractive indeed. On the supply side, cheap money also encourages buybacks, which cuts the quantity of shares in issue and pushes up the prices of those remaining.
It isn’t just equities, of course. There are bubble conditions aplenty in the bond markets. House prices in financial centres have soared. Hello “wealth”.
The (big) problem here is that not everyone gets this wealth, only people who already hold assets gain from price rises. The most obvious effect of very loose monetary policy has been to make the well-off even better off.
The second part of the plan isn’t working out brilliantly, either. Sure, across QE economies low rates have boosted borrowing and stimulated consumption. But spending tomorrow’s money today creates what economist Bernard Connolly calls “intertemporal disequilibrium.” If you have spent tomorrow’s money already you must either stop spending when tomorrow comes or, if you want to keep spending, borrow even more. The first brings recession. The second brings a credit bubble.
There’s more. Loose monetary policies prevent the creative destruction that is supposed to keep the capitalist show on the road. They encourage inefficient asset allocation and sway both trust and expectations. Who can have faith in the long-term sustainability of the economy and invest accordingly when their policymakers are obviously so inept that they have been in a state of monetary emergency for nine years?
If you could go back to 2007 would you really choose these policies again? Had they been used as short-term shock therapy only, the central bankers might have got away with it. As it is they have now made our economies more dysfunctional than ever — and, worse, they can’t find a way out.
The BoE also had a go as far back as 2011 at guessing what might happen when its extreme monetary policies were rolled back. The starting point was an “adjustment phase” in which asset prices fell. Reverse QE and you know you will reverse everything else, too. Goodbye “wealth”. And at a time in which public and private debt is fast approaching 300% of global gross domestic product, hello private sector debt defaults and new rounds of public sector fiscal constraint.
So what is the answer to all this? There isn’t one, really. The US Federal Reserve, where the great unwinding is to begin, is keen to let us all know that it will be very slow and very boring. Given the magnitude of the economic effects of the policy in the first place, and the fact that they have never done this before, that seems unlikely.
This is something to think about as you watch the world’s central bankers grandstanding at their gathering in Wyoming this weekend. They helped get us into this. They aren’t having much luck getting us out. But our elected governments have still ceded such enormous power over our financial system to them that we have no choice but to listen to their every word — if we want to have a chance of figuring out how the next (inevitable) crisis will play out, that is. Of all the things that have happened since 2007 that, I think, is the one that makes the least sense of all.
• This article was first published in the Financial Times