Central Banks Not Out of Options

There was an article by Reuters earlier that was linked on Yahoo Finance.  The title of the piece is "Analysis: Five years on, central banks not yet out of options".  I can't say that I disagree with the title.  The central banks, particularly the Fed, have more options with which to further destroy economic growth.

It is an interesting article with a variety of material covered, so I will just hit on a few points that stood out to me.

The article stated: "Conventional monetary policy may be constrained because interest rates in major economies are close to zero, but central bankers retain a plethora of less orthodox options and are increasingly likely to resort to them in coming months if growth prospects keep deteriorating.  Possible courses of action include buying private-sector assets, not just government bonds, and charging banks for parking funds at the central bank with the aim of galvanizing them into lending the money instead."

On the first point of buying so-called "private-sector assets", this is nothing new.  These rules were changed four years ago and implemented in late 2008 to bail out the banks.  The Fed gave a direct bailout to the big banks and financial institutions by buying mortgage-backed securities.  The major problem is that the Fed paid a much higher price than what would have been paid in the open free market.  It is as if someone bought a stock at $80 per share and the market price drops to $50.  The Fed comes in and buys the stock at the original price of $80, even though it is only worth $50 now.  It was a pure bailout.

On the second point, it is interesting that the article even mentions charging banks for keeping money at the Fed.  The Fed now pays a quarter of a percent of interest on excess reserves.  With the massive monetary inflation of the last 4 years has come a massive buildup of excess reserves by the commercial banks.  I think it is more out of fear than out of wanting a small .25% interest rate.  The article is correct that the Fed could start charging a fee and that this would press the banks into lending.  The thing the article doesn't mention is that the Fed is likely not going to do this because it will just cause a massive wave of price inflation.

Then the article talks about Mervyn King of the Bank of England.  In referring to King, the article asks, "Wasn't it time, he was asked, to try something more radical than 'quantitative easing'?  How about directly financing government deficits?  How about cancelling the bonds the BOE has bought to create room for tax cuts?  How about bypassing the banks and handing out newly printed central bank money to the public- the late U.S. monetarist Milton Friedman's famous 'helicopter drop'?"

Ah yes, the famous helicopter drop.  That is how Ben Bernanke got the nickname of Helicopter Ben.  So in other words, buying government debt indirectly by the central banks is not enough.  While King rejected the ideas, it is funny how many people are pushing the central banks to take "bolder" steps.  In other words, they want more direct inflation and more of it.

There are a lot of schemes being discussed by the "experts" and commentators on what central banks should do.  Their Keynesian style money creation has failed to work and they are desperate for more drastic measures, which will only make things worse.

The Federal Reserve (or any central bank) is not capable of creating wealth.  They can only stimulate the economy at the expense of the economy further down the road.  At some point, the game ends.  Either there will be a correction and a major reallocation of resources (which is what we need) or we will first suffer from major price inflation and higher interest rates.  But even in the second scenario, we will still eventually get a major correction.

There will be another correction regardless of what the Fed does at this point.  They can try charging banks for holding excess reserves.  They can try more "twisting" with buying longer-term debt.  They can try more quantitative easing and they can call it whatever they want.  They can try any scheme they want.  They are only delaying the inevitable, which is another major correction.