Central Banks Are Now Impotent

A lot of emphasis is being placed on the role of central banks in stopping the current financial market crashes, as well as in preventing economies sliding into recession. In reality, central banks have never been able to achieve the latter aim, and because they have acted to blow up the bubbles in property and financial markets, so many times in the past, that are now bursting, they have now put themselves in a position where they can no longer achieve that aim either. The air in their own tanks has been used up, so they have none left to puff more into those bubbles. It is a fact that the Governor of the Indian central bank, Raghuram Rajan, has pointed out in recent days.

In fact, it has been the action of central banks, over the last 30 years, in putting a floor under those financial and property markets – the so called Greenspan Put – that has created this condition. Conservative governments, particularly in the US and UK, sought to create an economic model based upon low wages and high private debt, with the latter being the other side of rapidly inflating asset prices, which in turn provided collateral for yet further borrowing. It was the model developed by Margaret Thatcher in Britain, and Ronald Reagan in the US.

Despite North Sea oil revnues, the deficit to GDP ratio
was much higher during the Thatcher/Major governments
than under the last Labour government, as Thatcher used
high levels of unemployment to smash the unions, and
thereby reduce wages.

In the UK, for example, at the same time that Thatcher used North Sea oil revenues to finance a massive rise in unemployment, so as to smash the unions, and workers' ability to resist pay cuts and job losses, she also deregulated financial markets so that banks and finance houses could lend without end, to people whose falling wages were increasingly going to be incapable of repaying the resulting debts. Whilst ordinary people's incomes were falling, they were deluded, by this policy, into believing that they were simultaneously becoming more wealthy, because the value, on paper, of their house was going through the roof, and if they had money in shares or bonds, they were going through the roof too – until, of course they didn't as in 1987 with the stock market crash, 1990 with the property market crash, 1994 another stock market crash, 2000 another stock market crash, 2007/8 another property market crash and 2008 yet another stock market crash.

But, the model required that these property and financial market crashes could not be allowed to do what they have always done in history, which is to clear away these bubbles, because that would prevent ordinary people from borrowing even more, going even further into debt, and without that, consumer demand, in economies that rely on high levels of consumer spending, would have collapsed. It would have meant that wages would have to rise, which would have undermined the model. In the UK, in the early 1980's, everyone had been encouraged by Thatcher to take on personal debt to buy their council house. Single people were given the idea that they must “get on the property ladder”, to accrue wealth out of thin air (unlike their parents who had lived at home with their parents, usually well into their 20's, and actually saved money, so as to be able to buy a house when they got married). They were missold pensions by Thatcher's newly deregulated financial services industry, and sold shares in the various privatisations and so on.

So, when in 1987, global stock markets crashed by more than 25% in a single day, this rather upset the scenario of ever rising wealth from nowhere that Thatcher and Reagan, and the other proponents of the magic of money, were trying to sell. Step into the picture, Alan Greenspan, newly minted Chairman of the US Federal Reserve. Greenspan was a devotee of Ayn Rand, and so also a proponent of “sound money” based on gold. Well, the US had already dismantled any connection of the dollar to gold – actually it should be gold to the dollar, because the price of gold had been fixed at $30, at Bretton Woods – in 1971, when Nixon, answered De Gaulle's requirement to have France's debts paid in gold, by removing dollar convertibility to gold, and making it illegal for US citizens to hold gold.

Greenspan, as the global capitalist system appeared to be disappearing down the plughole of the financial markets, ignored his commitment to “sound money”, and stepped in to slash interest rates, flood the economy with liquidity, and thereby brought the panic to a halt. In the following year, financial markets not only recovered the losses from the crash, but rose by 50%! It appeared that money magic could cure all ills after all, just as Milton Friedman and the Monetarists had claimed. It reinforced the idea that the economy could be tweaked using monetary levers, rather than the Keynesian fiscal levers that had been the orthodoxy from 1945-74.

But, rather like a game of whack-a-mole, having stopped the stock market crash by devaluing the currency, the consequence was, in Britain, to simply inflate another bubble. Between 1988-90, house prices more or less doubled. Then, in 1990, with inflation rising, and the UK also entering another recession, house prices crashed by 40%, taking them right back down to where they had been in 1988! Of course, hundreds of thousands of people who had bought at the top of the market, including tens of thousands, who had bought council houses, found they could not pay their mortgages, which had doubled, as mortgage rates rose, whilst they could not get back what they had overpaid for the house, because it was now worth only half what they had borrowed to pay for it! Tens of thousands of people were evicted, at a time when also Thatcher's policy had prevented the provision of alternative housing to accommodate them.

But, that set the scene for the period up to now. In 1994, as the Federal Reserve attempted to raise official interest rates, it sparked yet another stock market crash, as the price of bonds sold off, and interest rates spiked. In 2000, following the financial crisis in Asia and Russia, and with the potential for a further financial crisis, as a result of fears of the Millennium Bug, the Federal Reserve pumped yet more money tokens into circulation, which further fuelled the bubble in shares, particularly technology shares that had been running since 1995. The NASDAQ index, which had been rising by amounts of up to 70% a year, similar to the recent rise in the Shanghai Composite Index, fell in March 2000 by 75%. Fifteen years later, it briefly got back above its 2000 level, only to once again now fall back below it. So much for the idea, that shares or property always rise over the longer term. In fact, it was not until the mid 1950's, that US shares recovered the levels they had achieved prior to the 1929 stock market crash, and for most people that is too long a time-scale to have to wait, for it to do you any good.

Central banks have a role in providing liquidity into the economy to prevent a credit crunch similar to that which arose in 2008, or as Marx describes as happened in 1847 and 1857. But, that is all. They need to provide the currency required to enable the real economy to function, so that commodities can continue to circulate. But, they have no requirement to keep pumping liquidity into the economy to reflate crashed financial markets, and to the extent they do, they undermine both their own function, and the real economy. On the one hand, by reflating property and financial markets, they prevent the proper functioning of the market in clearing out excesses. There is clearly no rational basis for either stocks or property to be at the ludicrously high levels to which they have been pushed over the last 30 years.

That fact alone has meant that workers' housing and pension costs have been massively increased, which raises the value of labour-power, and cuts the rate of surplus value and profits. But, it also, as Haldane has noted, leads to a situation where the owners of fictitious capital are led to believe that this is a never ending upward spiral. Instead of money-capital being used to accumulate productive-capital, and thereby increase the mass of profits out of which interest payments can be made, it simply goes into fuelling ever more speculation, in the buying of existing financial assets at ever higher, and unsustainable prices. The two things are directly contradictory. The more money-capital goes into speculation, the less goes into accumulating real capital to produce the profits, which finance the payment of interest to justify the holding of fictitious capital! As Haldane puts it, “capital eats itself”.

QE was justified on the basis that it was needed to prevent global economies going into recession, but it could never have achieved that. The best it could do was to prevent a credit crunch sending the global economy into a recession. But, the amount of liquidity required for that, and the duration of such intervention, is very limited, whereas the extent of QE has been more or less unlimited. Had central banks allowed stock and property markets to crash in 1987, and not repeatedly intervened to reflate them, on every subsequent occasion, when they inflated, the current financial crisis would not have arisen.

That has been apparent in relation to the recent bubble in the Chinese markets, where there are numerous stories of individual producers who have diverted their available money-capital to stock market speculation that they would otherwise have used to expand their productive-capital. But, it is also visible in relation to major corporations, whose top directors over recent decades have focussed most of their attention on using profits for various forms of financial engineering to boost share prices, rather than in expanding the actual business.  That is because those directors are the representatives of fictitious capital not productive-capital.  They promote the interests of shareholders not the business itself.

QE could never prevent recessions, it could only act alongside Keynesian fiscal stimulus to increase the level of aggregate demand in the economy. In the 1980's and 90's, monetary policy and the encouragement of additional private debt acted to counter the drop in wages that Thatcher's economic model required, and the low productivity economy that followed from it. But, that was always going to be a time limited solution, because once the levels of private debt reached levels at which those individuals could no longer realistically either pay back the debt, or take on additional higher cost debt, the only answer is default. It is what has led on the one hand to the development of the large number of Pay Day lenders, and on the other to such a large number of people being in debt to them.

So, the policy of trying to promote aggregate demand by loose monetary policy and an encouragement of debt, alongside a policy of austerity, under current conditions, is bound to fail, and is failing. In fact, the growth that does exist in the global economy is despite rather than because of central bank and government policies. On the one hand policies of austerity take demand out of the economy, and cause uncertainty. On the other, monetary policy is encouraging speculation and draining money from productive investment, which would add both demand and capacity, provide jobs and income and profits.

What is more, not only is the monetary policy damaging real economic growth, but it is not now capable of even reflating financial bubbles. The Chinese central bank has cut official interest rates five times this year, but the Shanghai Composite continues to crash. The Federal Reserve and Bank of England have kept official interest rates on the floor, but the stock markets there also have continued to fall. What is more, even on the days that the central bankers announce that they will hold or cut official interest rates, the actual market rates of interest – the yields on bonds etc. – have been rising, which shows that the central bankers cannot dictate market prices.

The truth is that although China's economy is slowing down, it is still growing rapidly, and as Michael Roberts set out recently, those who are writing it off, are likely to be proved wrong as they have been several times in the past. Having said that, China does have several problems it needs to address. It needs to shift its economy more towards its own huge domestic market. To do that, it will need to do what every other developed capitalist economy has done, and create a welfare state. Industrialised capitalist economies require a welfare state, so that the workers do not engage in individual large scale savings to cover unemployment, ill-health, old age and so on. In that way, they can devote a larger portion of their wages to consumption. But, also industrialised economies need a welfare state, which acts as the provider of the quantity and quality of labour-power required by capital, at the least cost to it, and also acts as a large automatic stabiliser in the aggregate demand of the economy, avoiding the need for ad hoc interventions.

Global growth is not stellar, at the moment, for the reasons discussed above and in previous posts, but there is still growth. In the US, where the financial pundits continue to plead, on behalf of the speculators they represent, for the Federal Reserve not to raise interest rates, growth is still strong enough to suggest that the central bank is behind the curve and should have raised rates long ago, rather than holding off on raising them for even longer.

But, the reality is that, whatever the Federal Reserve, the Bank of England, the PBOC or any other central bank does, they have made themselves irrelevant. They have repeatedly blown up asset price bubbles when they collapsed over the last 30 years, and have spent up their firepower in doing so. With interest rates at zero, and their balance sheets blown up out of all rational proportion, they cannot now do anything to reflate property or stock markets, without risking hyper inflation. If central banks cannot now even suggest that they will raise official rates from zero to 0.25%, for fear that it will cause a stock market crash, then in reality, they may as well admit they can never raise official interest rates ever again, because with such extended bubbles, any rise in interest will always provoke such a crash, as Gary Kiminsky pointed out on Bloomberg yesterday.

So, as has happened in the past, and as the rise in bond yields over the last few days has shown, whatever central banks do, the market will ignore anyway. If the central bank does not raise rates, then the markets will do it for it, as the owners of money-capital begin to realise that the risk return has moved decidedly against them. That is really what is behind the current sell-off. The supply of money-capital is declining, whilst the demand for money-capital is rising, with the necessary effect that interest rates will rise. As Marx, Massie and Hume set out that cannot be changed by simply printing more money.

Yet, it is the latter that the central banks have essentially relied on as their only tool. But the tool is now blunted, it is a hammer trying to treat every problem as a nail.