The Inconvenient Truth About Central Bank Economic Policies

By John Schroder - July 3, 2015 
The inconvenient truth about political and central bank tinkering in the free markets is that distortions are almost always created.  Secondary effects, unintended consequences and distorted price or cost signals are the result (and in some cases with very negative consequences for the average citizen).  In addition, one must remember that the US Federal Reserve is a private corporation that exists to serve it's shareholders and customers.  Who are it's shareholders and customers?  Banks and other financial firms, which is in contrast to central banks in other countries that are directly owned by each respective government.  Now, with that said, the Fed was granted a corporate license to operate by the US Congress under the premise that it would serve some additional public good such as attempting to use policies to maximize employment, optimize GDP growth, promote stability of the money supply or whatever other such mandate.  However, when all is said and done, IF the US Federal Reserve has to make a choice between saving the financial or banking industry and saving the average citizen or the overall economy as a whole, you can be sure the banking sector will always take priority (and sometimes at the expense of the later).  In addition, they are scared to death of deflation and will also always prefer to promote inflation, once again if they have to make a choice between the two.  The western world fractional reserve fiat monetary system is predicated on debt, and inflation is the BBF of debtors and is the enemy of savers.  Once you clearly understand that, then you realize the Fed is not your friend if you personally attempt to manage your own financial affairs with prudence (you try to stay out of debt, or keep it to a minimum, and you try to save and invest whatever extra money you have).  This is not per say a criticism but rather to simply say that the US Federal Reserve (and other central banks) exist for a specific purpose and one must always consider this when analyzing their policies and objectives (and sometimes those policies will benefit you or your business, and sometimes not).


Some people were surprised at Mr. Ben Bernanke's recent comments and now that he is in the private sector once again, he speaks freely.  What was his supposedly shocking comment?  He said: Monetary policy is a blunt tool which certainly affects the distribution of income and wealth.  And that is one of the many inconvenient truths about central bank policies and one reason why there has been an increase  in wealth inequality in recent years (to be sure this was not the only reason).  Alan Greenspan is another former US Federal Reserve Chairman that is now coherently speaking some truths as well.  Incredibly enough, Mr. Greenspan used to be a believer in sound money (gold) when he was a young man affiliated with Ayn Rand's social circle but when he became US Federal Reserve Chairman, he switched religions overnight (so to speak).  Then, when he left the Fed and start doing private consulting once again (and giving economic speeches to private groups) he all of a sudden espouses the idea of gold and sound money anew.  And at one such speech giving event a member of the audience asked about the supposed non-political position of the Fed in terms of making economic policy and Mr. Greenspan honestly replied to the effect:  Are you kidding?  If you think there are no political influences on central bank policies you are mistaken.  He also has made some interesting and inconveniently truthful economic comments in the press recently such as: American productivity has gone nowhere in the last few years.  He also goes on to opine in a recent June 10, 2015 CNN interview that: We haven't come out of the bottom of the housing collapse, we are in a secular stagnation -  Single family housing is still only one-third of where they were in 2006 and earlier.  The CNN article goes on to explain that some cities are seeing buildings and prices rising, but construction of both homes and commercial properties overall isn't back to where it was before the Great Recession.  Greenspan has also weighed in on the Fed's zero interest rate policy and stock market valuations claiming that these artificially low rates has been responsible for the rise in P/E multiples and when rates normalize, that will reverse (Mr. Greenspan said while Fed Chairman that bubbles were difficult to predict or spot, yet now he clearly sees one in the equities markets).  Speaking about the increase of US Government costs or expenditures for things like Social Security, SNAP (what was formally called the food stamp program) and government social health insurance programs, Alan Greenspan opines that: the annual rate of increase in entitlements is 9% per year.  We would suggest you compound that out over the next few years (assuming these cost or expenditure increases remain the same, which we have do doubt they will) and see what that does to the US Federal Government budget.  In short, as we have been saying all along, this trend of increasing  social welfare costs and reduced government tax collection is not sustainable.  IF government social welfare contributions (taxes being collected) were increasing at a rate of 9 percent annually, they would be at least breaking even.  However, absent that scenario they are going deeply into the red.

One of the most scathing criticisms of Alan Greenspan comes from Mr. Dean Baker, writing an October 28, 2013 article in the The Guardian Newspaper (UK).  Mr. Baker goes on to say (quite correctly we think) that: Alan Greenspan will go down in history as the person most responsible for the enormous economic damage caused by the housing bubble and the subsequent collapse of the market.  The horror story could have easily been prevented had there been intelligent life at the Federal Reserve Board in the years when the housing bubble was growing to ever more dangerous proportions (2002-2006). But the Fed did nothing to curb the bubble. Arguably, it even acted to foster its growth with Greenspan cheering the development of exotic mortgages and completely ignoring its regulatory responsibilities.  Greenspan's  I didn't know excuse is so absurd as to be painful. The explosion of exotic mortgages in the bubble years was hardly a secret.  The fact that banks were issuing fraudulent mortgages by the millions, and that the Wall Street crew was securitizing them as fast as they could get them, was not top secret information available only to those with special security clearance. This was the economy in the years 2002-2006 (end of Mr. Baker's comments).

However, we hold no illusions as to what central banks are and do.  And of course in particular when discussing the US Federal Reserve, we again are not naive as to whom they are responsible to, what their concerns are and what they might do in the future.  It is all a carnival show with the Federal Reserve Chairman acting as front and center ring master.  Unfortunately however, we tend think the vast majority of average people tend not to sort through the economics data themselves (very boring stuff, I know) and often believe the public musings of central bankers.  Therein lies the problem.  The average citizen and the general public seem to be beguiled into believing the sound bites eschewed by such vaulted financial leaders and some may actually believe the central bankers are acting in the best interest of the common man or overall economy (they are not, but then again one must have no illusions to the contrary).

When governments manipulate financial data or reporting and when central bankers manipulate the otherwise free working of the economy by keeping interest rates artificially low, they send false economic signals to the masses.  If you cannot trust the statistics presented by your own government, then you have a problem making sound business or investment decisions.  Under the old soviet union of course such falsehoods were known and expected (they pretend to pay us and we pretend to work was one of the old paradigms under Russian Communism, just as we suppose one could have said that Pravda pretended to report the truth and the populace pretended to believe it).  But we are not talking about such a government here but rather a supposedly honest, free and fair democracy.  But perhaps not everyone is naive after all.  In a recent June 17, 2015 article penned by Mr. Ken Walsh for US News & World Report Magazine, Mr. Walsh contends that: Americans Have Lost Confidence In Everything.   Using information from a recent Gallop Poll, Mr. Walsh goes on to inform us that less than 10 percent of Americans (8 percent actually) have confidence in the US Congress.  In addition, it is reported that 28 percent of Americans have confidence in the banks (down from 40 percent) and overall: Although Americans are now more upbeat about the economy than they were in 2008-2013, they are not yet convinced that the economy is good, given that their assessments of national economic conditions remain more negative than positive.

However, in our opinion, one of the most dangerous and misunderstood (by the general public) inconvenient truths concerns the funding of government in general and specifically the financial mechanisms of the modern day social welfare state.  Too many people believe that all of the payments they have made in previous years were somehow placed in a trust fund to cover their own government health insurance or retirement needs.  Not so, as the funds that went in the front door immediately went out the back in terms of a transfer to those taking the benefits.  This entire wealth transfer system only worked providing there were more and more younger people coming into the work force to make such tax payments to cover those retired or otherwise taking out benefits of one kind or another.

Demographics of course has wrecked that model and any surplus of funds coming into the system was spent by the politicians (I am referring specifically to the so-called US Social Security Trust Fund, which is a misnomer if there ever was one).  If you need any hard core real life proof of this, you need to look no further than the current situation in Greece.  New political leadership in that country is desperately attempting to take a hard stand (as was their campaign platform to voters) and claim they do not want to cut government retirement or other benefits paid out by the state social welfare programs.  But where oh where did all the previous money go?  How and why is it they cannot now no longer afford to meet the social welfare commitments promised to the populace in years past?  And what does that say about the social welfare schemes in Spain, France, the UK, and so on?  Perhaps it is not that Greece per say is the exception, but rather the entire concept and execution of the modern day social welfare paradigm is finally showing it's weakness.  This is not to say that the idea of government assistance to those that need it is a bad thing, but rather the financial planning and execution of it by the politicians just might be.   Want a real life plausible example of what should have been done with the excess of funds that were accumulated in these social welfare pools in years past?  Instead of loaning those excess funds to the politicians via a government IOU or bond purchases, those excess funds should have been used to build toll infrastructure projects.  Meaning, new highways, bridges, airport facilities, port facilities and so on.  The tolls or user fees generated become a revenue annuity going directly into the social welfare payment pool and at the same time a lasting and real world economic benefit is created by an infrastructure project.  In this way also, there is no increase in national or municipal government debt and therefore no necessity to collect future income or other taxes from future generations to pay for borrowed money long ago spent on who knows what.        

Historically, we have been down this road before.  One must remember that an economic crisis occurred (or we probably should say crises, as in plural) during the 1920's and 1930's.  And just like then, we think there will be a renewed vigor on the part of these various governments to conduct what we like to call a robbery at pen point (as opposed to robbery at gun point).  Case in point was the economics minister in Germany in 1921, Mr. Robert Schmidt of the Social Democrat political party, who wanted to do something not very social nor democratic.  In short, he wanted to appropriate (read confiscate or steal) 20 percent of all stock and bonds owned by the so-called wealthy at the time.  In addition, he wanted a new 5 percent tax on all real estate.  These initiatives did not go through and as one might imagine business owners and those possibly effected were in an uproar.  But the point to be made it is when any government finds themselves in some kind of financial quagmire, those citizens that for whatever reason are still somewhat solvent (because they saved, invested wisely, or were fortunate enough to have a business or job that paid well) will become victims of a government robbery (the politically correct terminology might be forced patriotic donation).

And since we are looking at past (and possibly future) history, another interesting past parallel to the present involves the central bank of France in the early 1920's.  As it turned out, the French parliament in 1920 restricted the amount of bank notes (money) the central bank could print in order to place on check on any temptation to run the presses, as it were.  However France had a problem.  By keeping it's interest rates very low on it's government bonds (sound familiar?) no one wanted to invest in them.  And the reason the central bank in France did not want to raise interest rates was because they did not want to formally confirm the true higher market rate of inflation at the time (sound familiar?).  So, since there were no buyers, the central bank of France was the buyer of last resort, basically soaking up or taking possession of ALL the government bonds being issued.  But we then get back to the problem of what they could legally take or buy because in order to have the funds to buy up all these bonds, they needed to create more money out of thin air to do so, which they were legally restricted to do by law. 

The solution?  The French Central Banking Governor Georges Robineau and his lieutenant Albert Aupetit simply decided it was more convenient to falsify the books and break the law.  The alternative of course would be for the French Government to declare bankruptcy because the only way they could fund the constant annual budget deficit in a politically acceptable way (as opposed to raising taxes severely) was by issuing more and more government debt, and thus the French Central bank accommodated the politicians by illegally going over the monetary printing limit.  What happened to Messieurs Aupetit and Robineau?  Nothing really.  They were eventually forced to resign after publicly admitting they broke the law, cooked the books at the central bank and lied to both the parliament and the public.  But no criminal charges were filed, and life went on for these gentlemen.  However, if a business owner or any other individual citizen was caught lying on their income declaration (for taxation purposes) or omitted to report various kinds of income (such as overseas bank accounts or other kinds of investments theoretically subject to taxation in the home country) they would make an example of such an individual by locking them up and throwing away the key.  So, what we have here is a double standard in the extreme.      

Today of course we have what appears to be some very interesting parallels.  They say history does not repeat itself although if often rhymes a lot.  We have central banks today getting involved with so-called QE programs, buying up both sovereign and privately issued debt in some cases.  We have very strange occurrences of central banks from very small countries seemingly acting as a nominee or straw-man buying up US Treasury Securities, and often enough in amounts equivalent to one year's worth of GDP in said countries.  Where are they getting the money from?  Has the US Federal Reserve reached it's legal limit like the Bank of France so many years ago?  What about the ECB or European Central Bank and their own restrictions of financing government deficits with abandon, or in the least acting as buyer of last resort for fixed income securities?  Where will this all end?  How will this all end?  Are such central banks today being truthful or like Messieurs Aupetit and Robineau are they omitting to disclose their own inconvenient truths?

We have said many years ago and we say again, one cannot fix a credit boom-bust problem by issuing even more credit.  What occurred back in 2008 was the result of a classic asset bust fueled by excessive credit that has played out as precisely predicted by Austrian Economic Theory.  However, none of us can control what politicians or other kinds of bureaucrats (central bank functionaries) do, but we can at least be aware of what is real and what is simply propaganda.  After all, we ask the philosophical and perhaps moral question:  Why is it acceptable for politicians or even central bankers to break the laws of their own country without consequence or punishment (to supposedly save the government even though they are claiming to do so for the good of the overall economy), yet when individual citizens attempt financial self preservation of one kind or another to save themselves, they are branded social malcontents at best and criminals at worst?  The hypocrisy is deafening.  In the end, you have to look after yourself because no one else is going to do it for you.  That is the ultimate inconvenient truth.