Central Bankers’ Giant Gamble

Japan’s recent pledge to double its monetary base in an attempt to extricate itself from a two decade old deflationary cycle earns it a preeminent membership in the growing currency debasement club. The world is experiencing the greatest explosion of new money ever. Ostensibly, the exercise is designed to revive dormant, declining or barely growing economies. Since the 2007-09 financial crisis, the flood of new money has been singularly unsuccessful in promoting strong growth. At least in the United States, however, it has been eminently successful in pushing up stock prices.

Fed Chairman Ben Bernanke has made it clear that higher stock prices are a prime goal of current Fed policy. Observing Bernanke’s success in rallying stocks, other central bankers and government officials have taken their cue from Ben.

Mario Draghi’s “whatever it takes” pledge did marvels for stock prices throughout most of Europe until recent weeks. China Securities Regulatory Commission Chairman Guo Shuqing indicated even more specifically that it’s necessary to intervene in China’s stock market at “key moments” to accomplish government goals.

The Bank of Japan has attacked the problem most directly by pledging to flood the markets with new money, not just by buying bonds but by purchasing REITs and equity ETFs as well. I, among others, believe that our Fed has had a more direct influence on stock prices than it has acknowledged. In any case, it has so far convinced investors that, like Draghi, it stands ready to do whatever it takes to keep prices rising.

While Bernanke still controls a majority, other Fed governors are becoming increasingly uncomfortable with unlimited quantitative easing. Governor James Bullard yesterday called for an easing of the currently scheduled bond-buying program. Several other Fed voting members have voiced similar sentiments in recent weeks.

Some question the efficacy of the current program and readily admit to far less confidence than Chairman Bernanke that the Fed will be able to unwind this high-stakes experimental monetary policy. Voices from outside the Fed are getting louder as well. Among others, economists at the Bank for International Settlements, who claim their warnings of a credit bubble were ignored before the mid-decade financial crisis, are again pointing to unhealthy outcomes from seemingly uncontrolled monetary expansion.

Bernanke himself has admitted that his unconventional policies might not work “as well as we have hoped.” At a recent press conference, he added, “We’ll be learning over time how efficacious they are.”

Central bankers have apparently painted themselves into a corner. Debt levels have grown so immense that the Fed feels compelled to push interest rates close to zero so that debt service costs don’t overwhelm borrowers. They have tried to accomplish that objective across the yield curve by buying unprecedented amounts of fixed income securities, thereby increasing total debt levels. It is, of course, nonsensical to attempt to solve problems precipitated by excessive debt by adding more debt.

The lunacy of the current government approach is apparent as we observe monetary authorities now encouraging banks to ease their standards for real estate and automobile loans to include borrowers whose weak credit levels precipitated the prior crisis. The Fed is pulling out all stops in an attempt to avert a recession that would lead to another round of bankruptcies and foreclosures.

Former Fed Chairman Paul Volcker warned Monday about potential dangers from what he calls “unorthodox” and aggressive moves by central banks around the world. The King Report highlighted Volcker’s comments that central banks, including the Fed, could eventually inflict more harm by “what they’re doing with their portfolio to save the world economy…. Central banks are no longer central banks.”

The report added Black Rock’s Rick Reider’s contention that: “Fed policy has had a distorting effect on capital allocation decisions of all kinds at virtually every level of the economy.” Finally, Dallas Fed President Richard Fisher added a final condemnation, arguing that the Fed’s programs are not working, are benefiting the wrong people, and may even be counterproductive.