The Sage Who Saw It All Coming

A voice has been crying in the wilderness about the dangers of financial illusion and the impact of monetary policy decisions on genuine economic growth. The time to pay close attention to the damaging impact of central banks on productive financial investment for the real economy has arrived.The voice belongs to one of the most distinguished figures in the world of international finance, Jacques de Larosière, former managing director of the International Monetary Fund. He started sounding the alarm long before it became fashionable to lament the short-sighted perspective of commercial banks — and central banks — about the unrealized losses they were carrying on their balance sheets.Mr. de Larosière’s warning has been that unlimited issuance of sovereign debt at artificially low interest rates would undermine financial stability. Now his new book — “Putting an End to the Reign of Financial Illusion: For Real Growth” — is just out from Editions Odile Jacob and directly addresses the danger. It deserves to be read by government officials, financiers, legislators, and citizens in America as well as Europe.Mr. de Larosière, now 93, is uniquely qualified to judge the precarious state of global finance today, having held the top job at financial institutions throughout his career. He was managing director of the International Monetary Fund for the decade ending in 1987, then governor of the Banque de France, and president of the European Bank of Reconstruction and Development.Mr. de Larosière’s years at the IMF overlapped with the years during which the Federal Reserve was chaired by Paul Volcker, who greatly admired him. In this slim volume, available in both French and English, Mr. de Larosière asks the questions that are neatly sidestepped by central bankers in press conferences with docile journalists.“We all know that our world has been heavily indebted for decades and that its ‘financialization’ has reached proportions never before reached, at least in peacetime,” he asserts. “But how serious is this phenomenon? What are the consequences for the functioning of our economy and for the very future of our society?”Mr. de Larosière believes that government authorities have slipped into embracing a strange paradigm — in which the bulk of economic activity is defined as a rise in the value of financial assets to the detriment of the growth of wage income and productive investment.The explosion of balance sheets loaded with sovereign debt obligations has been facilitated by central bank purchases carried out in the name of accommodative monetary policy; the result is lost competitiveness.Borrowing to finance accumulated public deficits occurs at the expense of productive long-term investment that would yield greater levels of economic prosperity, argues Mr. de Larosière. “If the debt has only been used to finance deficits — and not productive investments — no new activity generating future income will have been created.” He believes that reduced growth will increase social inequalities and “jeopardize the future of our grandchildren.”The problem is that financial intermediation — the noble task of directing private savings into promising projects with the potential to raise living standards — has been transformed into a funding mechanism for government overspending. In the United States, say, commercial banks eagerly purchased Treasury obligations and mortgage-backed securities, knowing the Federal Reserve stood ready to buy them by crediting the bank’s deposit account of cash reserves.Those bank reserve balances, which exceed $3.4 trillion, are receiving 4.9 percent interest from the Fed. In addition, the Fed is paying 4.8 percent interest on $2.6 trillion in cash parked overnight by money market mutual funds. Annualized, the Fed is paying $290 billion on some $6 trillion held in cash — which requires an advance from Treasury since the Fed’s own portfolio earnings do not cover its expenses.One wonders how we could have reached this ludicrous moment where massive amounts of financial capital are highly compensated by the world’s most powerful central bank to remain sterile — not used for productive investment. Mr. de Larosière posits that monetary policy has undergone a radical shift from promoting stability to providing “permanent stimulus” to save the world from the aftermath of the 2008 global meltdown and then the pandemic starting in 2020.“We must not forget that it is the monetary policy followed for years, systematically accommodating, which contributed to shape a hyper-leveraged financial system vulnerable to crises,” Mr. de Larosière explains. The consequences include an increase in the wealth of financial asset holders that far exceeds the growth of real productive goods or the wages of the mass of the population.“Yet this is a question that seems to be of little interest to the economic profession, the leaders of the central banks and politicians,” Mr. de Larosière writes.It is notable that this French sage is praised by leading American economists on both sides of the aisle. “No one alive today combines Jacques de Larosière’s experience with an acuity about global finance,” commends Lawrence Summers on the back cover. “His sharp and cogent expression of alarm in this timely volume deserves and even demands the attention of the global financial community.”A former governor of the Federal Reserve, Kevin Warsh, describes the book as “a must-read for those who want to understand the ‘economic illusions’ hiding in plain sight.” Let’s hope that Mr. de Larosière’s piercing analysis receives the attention it warrants before it is too late.

The Sage Who Saw It All Coming

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