More Money: Magic or Voodoo?
A key theme in this column over the last three years and more – since the global crisis bottomed in the spring of 2009 – is that the great crisis that began in 2007-2008 is not over. Everything that has happened during those 3+ years represents an interlude, with the resumption of the crisis on an even greater scale left pending.
What has enabled this prolonged hiatus – so long and so substantive, at least in the global stock markets, that it is widely regarded as a distinct period of recovery and growth? The technical answer is ‘monetary policy’, which in simple terms means – money. The main central banks of the world – with the partial exception of the ECB – have embarked on a policy of monetary expansion, which involves pumping very large amounts of money into the financial systems of the countries and regions they oversee. This policy has had three main goals: initially, it was aimed at blocking and reversing the downward spiral triggered by the collapse of Lehman Brothers in September 2008; subsequently, it was designed to counter the unwillingness of commercial banks to undertake renewed lending, and of consumers to expand their borrowing. Finally, in the last year or so – and this time led by the ECB – the policy has sought to prevent the collapse of banking institutions and of entire banking systems in Europe, which would inevitably spread around the world.
The first stage was undoubtedly successful, because the world economy pulled out of its spiral of collapse during the first half of 2009 and global trade and business resumed more-or-less normal functioning. With regard to the second stage of the policy, the reviews are much more mixed, because commercial banks have on the whole remained highly conservative – indeed, it has been the central banks, in their other hat of banking regulators, that have obliged them to act that way, even had they wanted to be more adventurous. Consumer spending has recovered somewhat in the US, so on that count, too, the record is mixed. But even insofar as the loose money policy has been successful in its goals, that success has come at a huge cost – the massive and ongoing distortion of interest rates, and hence of economic activity, for several successive years. The damage stemming from these distortions mounts on a cumulative basis and ultimately becomes painfully apparent: China is perhaps the best example of how too much cheap money generates serious problems.
As for the third stage, that is still a work in progress. Clearly, the big European banks have not yet collapsed, so that is an achievement. But they still might, so the threat is by no means gone. Indeed, the current situation is that the entire financial system believes that the central bankers will continue to provide massive support and, arguably, that is what is holding the system together. There is ongoing capital flight from the countries of southern Europe, with the money moving to Switzerland, London and within the eurozone, to Germany and the other countries still regarded as strong. The ECB, via the mechanism of the joint eurozone payment system (known as TARGET), is channeling these flows and enabling the national central banks of countries like Greece and Spain to provide the liquidity in euro being demanded by the commercial banks in these countries and, ultimately, by the general public.
The ECB is not alone in this effort. On the contrary, the US Federal Reserve, the Banks of England and Japan and the PBOC (People’s Bank of China), are all heavily engaged in the ‘provision of liquidity’ – pumping money, in plain language. Will it work? The alternative is a global meltdown, the continuation and intensification of the events of 2008. So it had better work. But the real question is – how long can it continue to work? The impact of each successive round of ‘quantitative easing ‘ in the US and of similar or parallel measures in other countries and in the eurozone, has been smaller – the law of diminishing returns is plainly effective in this context too.
When the monetary magic – or “voodoo”, as Professor Joseph Steiglitz called it recently — stops working, the central bankers’ aura as the people able to put things right, or at least to stop them falling apart entirely, will fade. When people lose their confidence in the central bankers, it’s game over for the global financial system.