25th June 2012 by Shaun Richards
Yesterday whilst much attention was focused on England versus Italy in the Euro 2012 football tournament there was some support for one of my themes. Before I move on good luck to Italy as they move to the semi-finals.And as a counterpoint to some of the gloom in England I would like to point out that if you include the cricket and the rugby our record over the weekend was a much more respectable 1-1-1. Returning to the economics the Bank for International Settlements stood full square behind my argument that central banks are over stretching themselves and in effect are acting above their pay-grade. This is quite an irony when you consider that it is a by central bankers body!
What is the Bank for International Settlements?
Let me answer that with its own explanation.
The mission of the Bank for International Settlements (BIS) is to serve central banks in their pursuit of monetary and financial stability, to foster international cooperation in those areas and to act as a bank for central banks.
This role is often represented as being the banker to the world’s central banks of which some 60 are formal members. If you are in any doubt as to its potential influence then take a look at the constitution of its board of directors. It has amongst its members the Chairman of the US Federal Reserve, the Head of the European Central Bank, the Governor of the Bank of England as well as the Governor of the Bank of Japan. Actually I could go on but I think that I have made the point about its membership.
What does it do?
The BIS is in many respects a shadowy organisation in the background of financial affairs. It is easy to get paranoid about such bodies but I think a little care is needed as in my opinion it would be much better if the worlds central banks moved from the foreground to the background of world financial affairs!
It is involved in foreign exchange intervention although again often in the shadows. Perhaps the most open of its manoeuverings in this area is the way that it is often the conduit for intervention by the Swiss National Bank. Of course this is an area where it has been kept busy and indeed right now with the Swiss Franc to Euro exchange rate being at 1.2007 versus a cap of 1.20 if it were the Starship Enterprise then it would be at a minimum of yellow alert right now. And we see that it has been busy.
However, in May 2012, the SNB’s foreign exchange reserve holdings surged by more than 25% over the previous month as pressure on the minimum Swiss franc per euro exchange rate heightened
The BIS has also been involved with the construction of the Basel rules for bank capital and liquidty requirements. As we are in the middle of a banking crisis it is clear that this part of its role has been much nearer to a disaster than a triumph.
What does the BIS think about central banks right now?
First we get a statement of the obvious telling us that many of the worlds central banks have extraordinarily accomodative (expansionary) policies.
the stance of monetary policy is accommodative globally
But very quickly we get a warning.
But there are limits to what monetary policy can do.
And added to it is an implicit criticism of the role of those in charge of the Euro amongst others.
It can provide liquidity, but it cannot solve underlying solvency problems.
It is nice of the BIS to agree with my point that central banks are operating beyond their paygrade.
The growing gap between what central banks are expected to deliver and what they can actually deliver could in the longer term undermine their credibility and operational autonomy.
And then they choose to hit harder by coming solidly behing my theme that some of the central bank action has the danger that it may make things worse rather than better.
Prolonged and aggressive monetary accommodation has side effects that may delay the return to a self-sustaining recovery and may create risks for financial and price stability globally
In essence if we allow for the coded nature of the language they are agreeing with my argument that central banks have become like drug-dealers continually supplying more doses of monetary expansion to clients who become more like junkies with each further dose. So that in addition to the danger of the world economy in effect being on a “high” in response to this there is of course the hangover or “low” to come. But the highs get ever shorter.And even worse the low is always kicked like a can into the future meaning that it will be deeper and longer when we are finally allowed to catch up with it. Or as the BIS put it later in their report.
A vicious circle can develop
How much of the drug have we received?
Added to the way that interest-rates have been cut we have seen this.
Total assets held by central banks have more than doubled over the past four years and stood at approximately $18 trillion at the end of 2011
As many of you have replied in the comments section these numbers are now so large it is very difficult to have a clear concept of what they mean. And let me apologise for yet another number larger than the ones that have gone before! Another type of inflation which shows no signs of abating.
And we see a concentration of this in what we have become used to calling the advanced economies.
In the advanced economies central bank assets rose to about 25% of GDP
However there is already collateral damage: remember the “currency wars”?
This subject is almost entirely ignored by the mainstream media but a consequence of the monetary easing has been this.
These extraordinarily accommodative monetary conditions are being transmitted to emerging market economies in the form of undesirable exchange rate and capital flow volatility.
Indeed and this was what led Brazil’s Finance Minister to coin the phrase “currency wars”. But there is more.
In the major emerging market economies, central bank assets stood at roughly 40% of GDP at the end of 2011, reflecting the large accumulation of foreign exchange reserves over the past decade, in particular in emerging Asia.
So in attempting to deal with imbalances have central banks contributed to the creation of another one? Or are they implicit fans of West Ham football club’s theme song?
I’m forever blowing bubbles, Pretty bubbles in the air.
So we see that a concentration of assets in the central banks of the advanced economies has contributed to an even larger accumulation in the emerging economies.
The BIS is more worried than it is willing to fully admit
Here it is only one word but a word which has considerable implications. You see not so long ago the word probably would be missing from the sentence below. If you read it without it you get an entirely different emphasis and meaning and that is my point.
Decisive action by central banks during the global financial crisis was probably crucial in preventing a repeat of the experiences of the Great Depression
The cause of the switch is in essence the banking sector. The BIS is (correctly) worried that the policies pursued may have delayed necessary reforms.
low interest rates reduce the opportunity cost of carrying non-performing loans and may lead banks to overestimate repayment capacity. All this could perpetuate weak balance sheets and lead to a misallocation of credit
Yes and as to bank reform we see that the BIS are worried by what the Eagles sang thus.
You’re afraid it’s all been wasted time
In a way the most daming citicism of the world’s central banks comes in this sentence here.
the high degree of uncertainty about the level and growth rate of potential output
As we are seeeing a confession here that the extraordinary moves have been taken in effect “blind” as to their result. And whilst individual central banks claim their independence is unaffected as a group they suddenly seem much less sure.
The very meaning of instrument independence therefore becomes unclear when central banks engage in large-scale balance sheet policy measures
Let me help them out, it means you are no longer independent. In some ways mere discussion of the subject implies that independence has been lost.
It is interesting that the BIS is confessing here that the intellectual argument about central bank intervention has been lost. However I counsel caution about expecting a change of policy. If we look at its board members we have recently seen Governor King vote for an extra £50 billion of Quantitative Easing and Chairman Bernanke of the US Federal Reserve vote for a US $267 billion extension to Operation Twist! No doubt the Swiss National Bank will also continue its Euro accumulation campaign.
So there you have it central bankers are in a state of uncertainty and doubt but are likely to do the following.
Carry on Regardless
Royal Bank of Scotland
It is not my intention to scaremonger here so let me remind everyone that RBS is backed by the UK taxpayer. But as the “glitch” goes on and on and reaches nearly a week isn’t it good that we appointed a new board who really understood banking and could get to grips with the bank? Oh….
Imagine the problems right now if RBS was based in Athens or Madrid.