It’s hard to imagine central banks getting even wilder, but never underestimate government expansionism. That’s the red flag raised by the Financial Times with its headline Wednesday: “Helicopter drops (of money) might not be far away.”
Columnist Martin Wolf argues that, if the fiscal authorities are unwilling to behave sensibly by expanding public investment, the central banks should step in: “Give central banks the power to send money, ideally in electronic form, to every adult citizen... (generating) a permanent rise in the reserves of commercial banks at the central bank.”
In a speech Tuesday, the vice chairman of the Federal Reserve, Stanley Fischer, left the door open to the central bank imposing negative interest rates in America. “We’re looking at it, and I can tell you we have no plans to do it at present and I think we’re some ways away from that. You look at things, you study them, and you ask how they work. One way they work is they do not impose negative rates on small retail customers.”
This leaves the Fed open to the European and Japanese practice of applying negative rates to big depositors. That would penalize just the type of funds an economy needs for growth. Even without those new extremes, central banking is already walking on the wild side.
Using the 2008 crisis as an opportunity for expansion, the major central banks purchased huge portfolios of bonds, funding almost all of the expansion through banks. The Fed now has liabilities that are 112 times its capital — after Congress withdrew $19 billion of the Fed’s equity capital in late 2015 to claim as an offset against extra spending.
The Fed pays banks billions a year for its funding — between $14 billion and $20 billion in payments are expected in 2016, with no limits on future payments. Chairman Yellen and her predecessor, Ben Bernanke, defended these payments in recent presentations on the grounds that the Fed makes a profit on its portfolio and turns it over to Congress to support spending.
At first, this sounds a lot like the proverbial free lunch, but the catch is that it exposes taxpayers to interest rate risk in the same way a highly leveraged hedge fund is at risk. In the Fed’s case, if the market goes the wrong way, the taxpayer will foot the bill.
As part of their expansion, central banks have basically taken over the government bond markets in Europe, Japan, and America. The European Central Bank even buys low-rated bonds, not just the AA and AAA positions taken by the Fed, and makes billions of euros in low-interest-rate loans to banks.
Meanwhile, the Bank of Japan is buying stocks and real estate, not just bonds. The People’s Bank of China is even more aggressive, using central bank assets to speculate in currencies, foreign bonds, and loans to industrial conglomerates.
With recessions and deflation spreading, the FT’s Mr. Wolf sees “fiscal expansion” as the next step, saying it is unlikely to be the end and may lead to “direct monetary support.” Under this approach, a central bank would borrow even more from banks — Mr. Wolf describes a permanent rise in bank reserves — to give money to the public.
As Mrs. Yellen and Mr. Bernanke explained in recent presentations, central banks create matching liabilities when they buy assets, not the “money printing” activity often attributed to them. Thus, Mr. Wolf’s proposal would increase the liabilities of the nation, the combined national debt, and the net debt of the central bank.
The line between monetary and fiscal policy is already blurry. Whether money is spent by the Treasury or the Fed, it comes from the private sector. In both cases, the money is distributed by the government, and the net debt of the central bank should be counted as part of the nation’s debt burden.
It’s urgent that the Fed alter course. The worry hanging over the global economy is that price declines will spread from oil and trade into real estate. Central banks haven’t been able to identify tools to stop deflation, so if it starts, it might become a deflation spiral.
The Fed and other central banks seem trapped. The Paris-based, American-funded Organization for Economic Cooperation and Development just lowered its 2016 growth forecast, saying: “The world economy is likely to expand no faster in 2016 than 2015, its slowest pace in five years.”
Central banks are likely to keep responding to slow growth using their current tools, bond buying, and interest rate cuts. Those make conditions worse, risking a spiral. Japan recently announced negative interest rates and almost simultaneously admitted that it had fallen into another recession despite the world’s biggest bond-buying program.
Switzerland has set its interest rate at minus -0.75% in the hopes of stimulus, but it’s not working. January CPI was -1.3% year-over-year, and core CPI was -0.9%. In desperation, a referendum on the June 5 ballot proposes that the government pay each citizen roughly $2,500 a month, funded three-fourths by the fiscal deficit and one-fourth by transfers from the social security fund.
It’s unlikely to pass, but the direction is clear. Keynesians contend that money causes consumption and hope that this will create production and jobs. Instead, it is the profit opportunity that causes production and jobs. That creates consumption and money, not the other way around.
Central banks are looking for ways to prime the pump of consumption using negative interest rates (and maybe fiscal transfers). It isn’t likely to work. Rather than doubling down on past policies, the Fed should downsize — reducing, in particular, its massive bank debt — and improve regulatory policy to accelerate the growth in credit and money supply.
Mr. Malpass is president of Encima Global LLC.