Part 1 of a three-part series
I do not suppose that central bankers like to be compared to witches, but for my money the best account of how the financial crisis came about is in Macbeth. Banquo warns Macbeth to be wary of the witches’ implied promises:
And oftentimes, to win us to our harm,
The instruments of darkness tell us truths,
Win us with honest trifles, to betray’s
In deepest consequence.”
Before the crisis, our latter-day ‘instruments of darkness’ also told us truths and won us with honest trifles; they gave us the Great Moderation, as they had promised. So, like Macbeth, we willingly fell under their spell. And then came the Great Betrayal.
The problem is that we remain spell-bound. Consider the following:
- Financial instability has become endemic to the world economy; thus, many expect a recurrence of the global financial crisis. But we do nothing effective to prevent it.
- The same policy response, repeated after each crisis, lays the basis for the next one. In each cycle, rates are driven lower and lower, this time to near zero (White 2013). After each crash, financial regulation is tightened, although we are aware that lax regulation was not a primary cause of the crisis.
- We grant central banks/regulators more responsibilities and powers. These powers have risks; over time, they may undermine social order, the foundations of capitalism and the rule of law.
- The credibility of central banks has been damaged and inflation targeting frameworks have lost traction; yet little serious thinking has been given to replacing them.
- The suppression of long-term market interest rates for extended periods undermines the capacity of the monetary mechanism to perform its signalling functions.
- Thus, is it surprising that economic recovery proceeds, in the OECD’s words, by ‘fits and starts’ (OECD, April 2013)? The echoes of Macbeth are striking. Lady Macbeth: ‘The fit is momentary; upon a thought He will again be well’. Macbeth: ‘Then comes my fit again’; Lady Macbeth: ‘O, these flaws and starts, Impostors to true fear.’
- Central bank/regulatory policies fragment markets, ‘balkanize’ banks’ capital and liquidity resources and erode banks’ role as intermediaries.
- Few insiders have confidence in Basel III and some have lost faith in the whole Basel process – but they kid us into believing in it.
- Despite an improvement in funding conditions for banks in the euro area and US, mega banks are kept afloat on an ocean of liquidity courtesy of central banks. According to the head of financial stability at the ECB, national banking systems still depend ‘excessively’ on their respective public sectors (Angeloni, 2013).
- In the US, the housing finance market remains dependent on the government (see FSOC report for 2013).
- Little progress has been made to rationalise regulatory bodies in the US. ‘It’s a recipe for getting nothing done. This really is a disaster,’ the Wall Street Journal quotes Paul Volcker (WSJ, May 23, 2013) as saying. Three years after the passage of the Dodd-Frank law, regulators still haven’t agreed on a way to implement the ‘The Volcker Rule.’
- Central banks’ quantitative easing combined with fiscal austerity (which most of them support), are increasing levels of income and wealth inequality, which bring about the decline and fall of states.
- Central banks tell banks to hold more capital in relation to their assets (loans and investments on their books). The banks obey. Lending falls, impeding recovery.
We bear the costs of such policies. For example, we submit meekly to an ever-spreading web of controls over financial institutions and markets. We are oblivious to historical experience, for example in the post-war period 1945-1960, which shows that such a ‘collectivist’ approach to monetary matters is unlikely to produce desirable or efficient results.
‘The erosion of confidence and trust in the financial world, in the financial authorities that oversee it, and in government generally is palpable, ‘ says Volcker
Confused by conflicting signals, driven by doubtful prophecies, fear and greed, people act irrationally, as Macbeth did.
That is the money trap, as described more prosaically in my book. Promises of bliss lure governments, financiers and consumers into acting against their true interests.
Story to be continued….Part 2 coming soon!