Central Banks Want Out

Bank of International Settlements General Manager, Jaime Caruana
[courtesy Google Images]

Jaime Caruana is the BIS General Manager and ranks with Ben Bernanke as two of the most knowledgeable and influential bankers in the world.

Mr. Caruana delivered a speech last June 23^rd at the BIS Annual General Meeting.  The speech fascinates because: 1) it comes from the world’s leading banking authorities; 2) it advises against going deeper into debt; 3) it does not exude a sense of economic optimism; and 4) it implicitly advises central banks (including the Federal Reserve) to run like hell.

●  According to Mr. Caruana, when the Great Recession began in A.D. 2008, it caused central banks and national governments to work together to support national and global economies with “unprecedented measures”.

These measures included buying “toxic [worthless] assets”, Quantitative Easing (inflating the currency supply) and near-zero interest rates.  The purpose for these monetary measures was to increase public borrowing and debt so as to “stimulate” economies to sell more, produce more and thereby avoid a national or even global depression.

These “unprecedented measures” had some success:

“Without these forceful and determined policy responses, the global financial system could easily have collapsed [after A.D. 2008], bringing the world economy down with it. But the subsequent global recovery has remained halting, fragile and uneven.  In the United States, the expansion continues, albeit at a moderate pace. In major emerging market economies, growth is losing momentum. Most of Europe has fallen back into recession.”

The central banks’ “unprecedented measures” bought time for national and global economies to recover.  However, as a result of this stimulation, central bank balance sheets—based on the purchase of “toxic assets” which have a book value of, say, $5 trillion but a free market value of, say, $500 billion—doubled from $10 trillion to more than $20 trillion. The banks’ balance sheets are inflated by false valuations of the “toxic assets”.  That’s fraud.

Similarly, many governments “have been piling up debt, which has risen by $23 trillion since 2007.”  Mr. Caruana implies that, since A.D. 2008, as much as $30 trillion in fiat currency has been issued by central banks to prevent a global depression.  The problem with that $30 trillion in “stimulation” is that it’s necessarily balanced by $30 trillion in new, global debt—much of which will never be repaid.

Even so,

“As the risks mounted around mid-2012, central banks rode to the rescue yet again . . . with a conditional programme to buy sovereign [governmental] debt of troubled euro area countries. The Federal Reserve, the Bank of England and the Bank of Japan likewise pushed forward with additional expansionary measures.”

Central banks, which had initially worked with governments as partners to issue credit to private corporations and individuals stimulate their national economies, are now issuing credit all by themselves to support insolvent governments.   We see this phenomenon in the Federal Reserve’s current purchase of over 80% of the bonds issued by the United States.  The US and other governments are financially exhausted.  Private lenders have shunned US bonds.  Central banks are the only remaining source of funds sufficient to prevent or postpone an economic depression.

●  Insofar as people and corporations were willing to borrow and go deeper into debt, the central banks’ “stimulation” seemed to work.

“But easy financial conditions can do only so much to revitalise long-term growth when balance sheets are impaired and resources are misallocated on a large scale.”

Central bank balance sheets were impaired by buying “toxic assets” (such as mortgage-backed securities) that were accounted as ostensibly valuable when everyone knew they were virtually worthless.  Private corporation balance sheets were impaired by going deeper into non-productive debt.  The balance sheets of insolvent governments were concealed by political fraud.

“Resources [were] misallocated on a large scale” by government programs that diverted huge sums to institutions that might be “too big to fail” but weren’t truly productive.  Trillions of dollars that would’ve been better spent on industries were instead given to Wall Street financial institutions.

Again, these “unprecedented measures” bought time for national and global economies to heal and delayed the Greater Depression—but didn’t generate increases in productivity sufficient to eliminate the possibility of a global economic collapse.

Because household debt remained high, consumers worked hard to reduce their current debt loads and therefore refused to borrow.  The “unprecedented measures” weren’t stimulating the consumers to borrow and buy.

Corporations, on the other hand, were willing to borrow, but used that “cheap bond funding to lengthen the duration of their liabilities instead of investing in new production capacity.”   I.e., corporations used the “easy money” provided by central banks to refinance their existing debt rather than create more productive (largely, industrial) jobs the world needs to actually escape the Great Recession and avoid the Greater Depression.

●  The post-2008 injection of “easy money” into the economy did not provide as much “stimulus” as had been hoped for.  De common folk knew that debt had grown too great and wouldn’t borrow to buy more stuff.

Result?  The “recovery” languished.

In a debt-based monetary system, Quantitative Easing—giving $85 billion a month to banks to lend to customers in order to “stimulate” the economy—can’t work if consumers aren’t willing to borrow and go deeper into debt.  (“You can lead a consumer to a bank, but you can’t make him borrow.”)

More, according to Mr. Caruana, the currency injected by governments and central banks into the economy wasn’t an unmitigated blessings:

 “Debt-financed growth [stimulation] masked the downward trend in labor productivity and the large-scale distortion of resource allocation in many economies. Adding more debt will not strengthen the financial sector nor will it reallocate resources needed to return economies to the real growth that authorities and the public both want and expect.”

The “easy money” was going to the wrong recipients.  It wasn’t enough to simply scatter money from helicopters into the economy.  The money had to be primarily given to productive entities rather than financial entities.  But that wasn’t happening.

“Moreover, such borrowing has costs. As the stimulus is sustained, it magnifies the challenges of normalising monetary policy; it increases financial stability risks; and it worsens the misallocation of capital.”

Mr. Caruana wants a return to “tough love” banking where funds are allocated to people, businesses, and  governments based on their ability to produce rather than their need to consume.

Since the onset of the Great Recession, the only entities going more deeply into debt have been insolvent governments . Central banks are being jeopardized by being forced or at least cajoled into lending at near-zero interest rates to governments that surely can never repay their loans in full.  Some governments had already gone broke and were relying on central banks to bail them out.

It’s only a question of time before the central banks also go broke from making loans to governments that won’t be repaid.   Once the central banks go broke, the governments will have no further source of funds, “stimulus” (like Quantitative Easing) will end, and  national and/or global economies will collapse.

●  Mr.  Caruana entitled one subsection of his speech, “Ending the dependence on debt”.

Coming from a banker, that’s a strange sub-title since banks earn their incomes from debt.  To recommend that the world end its dependence on debt is very much like recommending the world end its dependence on banks.   If a banker recommends a significant reduction in world debt, the world’s financial system must be in a lot of trouble.

I.e., if we end our dependence on debt, then we’ll also end our access to credit.  No borrowing for the majority.  Cash and carry for the peons.  Credit only, and then rarely, for governments and/or major corporations.   There’ll be a premium, even a black market, for capital made available to the average man.  Loan sharks and outright theft will replace local banks.  Without real capital (gold/silver) or access to credit, the majority of the world will slip deeper into abject poverty, violence and government corruption.

Nevertheless, debt should be reduced because:

“Extending monetary stimulus is taking the pressure off those [government officials] who need to act. Ultra-low interest rates encourage the build-up of even more debt . . . . in some countries, total debt , private and public, has generally increased as a share of GDP since 2007. For the advanced and emerging market economies . . . it has risen by about 20 percentage points of GDP, or by $33 trillion—and rising government debt has been the main driver. This is clearly not sustainable.”

Insofar as Mr. Caruana:  1) wants to reduce the world’s debt;  and 2) believes government is the “main driver” behind the world’s (and certainly America’s) debt; then, 3) Mr. Caruana implicitly advocates that governments be prevented from going any deeper into debt.

Can the public bring sufficient political pressure to make government give up its addiction to debt?

No—not in a nation where half the people receive government welfare or subsidies.

Can a government like that of the United States—based on nothing more than moral rectitude and the strength of government “character”—be expected to voluntarily quit its addiction to debt?

Of course not.

Therefore, if the people won’t force government to stop borrowing, and the government won’t voluntarily stop borrowing, how can the borrowing (and resulting debt) be stopped?

A:  The banks have to stop lending to government.

Which banks?

The central banks—they’re the only ones making significant loans to insolvent governments.

Thus, we’re treated to spectacle of the General Manger of the Bank of International Settlement implicitly advising his “customers” (the world’s central banks) that they should stop lending to the world’s governments.

●  Admittedly, Mr. Caruana did not expressly advise the central banks to stop lending to governments, but that implication is clear in his June 23^rd speech.

More, this is not a new idea.  Federal Reserve Chairman Ben Bernanke advanced much the same idea just one month earlier (May 22^nd) when he addressed the Joint Economic Committee at Congress and expressly proposed the idea of “tapering”.

I.e., the Federal Reserve would stop taking the federal government’s IOUs for the $85 billion in Quantitative Easing (QE) being injected into the economy each month.   These “injections” would not stop all at once.  They’d “taper off” from $85 billion, to maybe $70 billion for a few months, and then maybe $55 billion for a few more months, etc., until the economy was eventually weaned from its addiction to debt and the QE “injections” were finally brought to zero.

Wall Street investors reacted within minutes of Bernanke’s tapering proposal with a sudden downward spike in stock prices.  A shell-shocked Ben Bernanke quickly changed his shorts and within days declared that he was jus’ spitballin’ about that “tapering” thing and we could all rest assured that our $85 billion monthly fix would continue without interruption.

The equities markets resumed their upward trajectory and there was peace in Wall Street’s valley.

It’s not surprising that Mr. Caruana would’ve learned from Mr. Bernanke’s May faux pas. Therefore, Mr. Caruan only implied (rather than expressly declared) in his June speech that the central banks should reduce their lending to governments—especially to the U.S. government.

But it is surprising that just one month after Fed Chairman Bernanke unsuccessfully advocated tapering, that the GM for the Bank of International Settlements would do the same.

I can’t believe that it’s a coincidence when the world’s two most important bankers both recommend that governmental debt must be diminished.

Instead, I read Bernanke’s May speech and Caruana’s June speech as evidence that the central banks of the world want to stop or at least reduce lending to the world’s governments.  The central banks want out.

If that conclusion is valid, it implies that the central banks want to distance themselves from the world’s governments because one or more of the following are deemed true:

1) The central banks know that the currency they lend to insolvent governments will never be repaid in full;

2) The central banks know that they, themselves, might go broke if they continue to lend an endless stream of eventually hyperinflated currency to world’s insolvent governments; and/or,

3) The whole, darned system is on verge of collapse; it’s every man (and bank) for himself and the central banks should at least save themselves since they can’t save the governments and national/global economies.  The rats want to abandon ship and swim for it.

●  Unfortunately, the US and global economies are now so addicted to the central banks’ fiat currency, that any suggestion of a reduction could trigger a stock market and/or economic collapse.  And who’d be blamed for such collapse?  The central banks.

When the Great Depression began in A.D. 1929, very few people knew who to blame.  Some blamed Wall Street; some blamed government; some blamed the bankers.  More, there was no consensus that there even was a depression until around A.D. 1933.   Eventually, a lot of people came to believe that the Federal Reserve caused the Depression by tightening up on the public’s access to credit.  But that opinion took years or even decades to develop.  By the time America agreed that the Federal Reserve caused the Great Depression, the crash of A.D. 1929 was old news and interesting but not cause for retribution.

Today—thanks to the internet—if we have an economic crash at noon, there could be people screaming for the heads of every Federal Reserve officer by the end of the week.  There’ll be little doubt and less delay. Passions might erupt almost instantaneously.

Would the great unwashed therefore attack the “evil” central banks with bricks, bullets and firebombs?

Who can say?

But we clearly live in “interesting times,” and those times aren’t merely “interesting” for those of us who wonder if we’ll have any food in six month.  They’re also “interesting” and even scary for a lot of rich people who currently sit in seemingly powerful positions.  They may be rich and powerful, but they aren’t safe.

The world’s central banks are caught in circumstances analogous the last meth dealer in Brooklyn.  If he stops supplying the junkies, he’ll have addicts chasing him down every street in town.  The addicts will blame that last dealer for cutting off their meth and they’ll want his blood.

Same thing with the world’s central bankers.  They’re our fiat currency “dealers”.  If they dare stop providing our fix of fiat currency (Quantitative Easing), they just might get themselves lynched.

I think the central bankers are caught in an untenable position.  They can’t keep lending. They want to quit lending.  But they can’t stop lending.  They’re darned if they do, and darned if they don’t.

●  What’s that mean to you and me?

If my analysis is correct, it means that we’re in a situation a lot like taking a vacation on a Carnival Cruise Line ship.  We’re in the middle of the Caribbean and everything seems wonderful.   The sun’s shining, the sea is blue, food is good, entertainment is fine, and the mojito’s are great.

Just one little problem.  If you sober up long enough to look around with an objective eye you might notice the captain and crew trying to quietly abandon the ship.

Does that mean you and I should stay close to a life boat?  Or is it merely reason to celebrate that there’ll be more mojitos for you and me?

Clearly, if the “captains” (like Ben Bernanke and Jaime Caruana) try to abandon the ship of debt, we must be close to serious trouble.

The Federal Reserve and the Bank of International Settlements both want to stop lending to governments.  That can’t be a good sign.

Find a lifeboat and stay close.