Essay by Dr. Tillmann C. Lauk; presentated at the ECAEF Workshop, in Bratislava on September 8, 2016
Since the GFC1 of 2008 all central banks of the Triade are pursuing the same monetary policies. All central banks of the advanced-/over-indebted economies stick to this recipe. The main tools are QE2, ZIRP3 and NIRP4 and possibly in the future „helicopter money“ and a ban of cash. All tools have in common that they are highly repressive, malicious for the economy (mal investments), they stealthy expropriate savers, and massively hurt retirees. What the tool-kit of central banks is targeting at:
• Quantitative Easing means buying assets from the commercial banking system which in return gives cash to the private banking sector. The money required for those purchases is simply „printed out of thin air“.
• 1st Rationale: increase credit to the economy in order to stimulate aggregate demand = what is supposed to spur productive investment and employment.
• 2nd rationale: create a wealth effect through raising asset prices = equities and other (financial) assets.
• 3rd rationale: through this increase of the money supply try to create controlled inflation and to devalue currencies in the hope to stimulate exports.
• 4th rationale: ZIRP or even NIRP aim at (a) bringing down the debt service obligations of the ever increasing sovereign debt and (b) forcing savers to spend.
Now, let’s check whether data support that statement …
It has been the intellectual fashion among commentators, politicians and some economists to claim that the financial crisis of 2008 and the ensuing economic downturn were caused by excessively free markets, or “turbo-capitalism.” From this they deduce that free markets foster inequality, and that inequality is the main source of today’s social and economic problems.
The result is a cry for more regulation and government intervention whose aim, in the words of one German finance minister, is to put the markets on a leash. We certainly need sensible regulations. But in this context, we should not forget the best and most efficient regulator. That would be competition, which keeps markets clean, honest and working for the best interests of all stakeholders and society in general. It must also be admitted that the biggest problems arose in the most highly regulated sector: the global financial industry. The tangled thicket of regulations favored large players (“too big to fail”) and led to concentration. This encouraged cartels and unethical price-fixing, as shown in the Libor scandal. Such malpractice by a handful of big players appears to have been silently tolerated by the regulatory authorities.
Meanwhile, irresponsible and populist overspending by governments over the past 30 years led to large budget deficits and sovereign debt. One of the main reasons why central banks adopted a policy of easy money was to alleviate this fiscal burden. Money is the raw material of the financial system. As in any industry, government intervention to keep raw materials cheap will distort markets, exaggerate profits and encourage waste and abuses. The problems in the financial sector were created by a regulatory concentration of the industry combined with cheap money. Capitalism, based on competition and free markets, was replaced by regulations and government intervention. In order to camouflage the crony system between governments and big banks, the term “turbo-capitalism” was coined. True markets and capitalism took the blame.
It did not stop there, however. Capitalism and free markets were also blamed for inequality, which was identified as the fundamental problem. This diagnosis is totally false. It is true that inequality is rising. But one has to analyze the reasons carefully before jumping to populist, ideological conclusions. Liberalization of markets for labor, goods and services has helped approximately 1 billion people escape from poverty over the past 25 years. In both magnitude and speed, this is an unprecedented step.
But an era of cheap money has brought huge problems. Zero to negative interest rates have destroyed the personal savings of vast numbers of people, encouraged a culture of debt and threaten to wipe out pension savings. Poverty may again become the norm among elderly people in the developed world.
A side effect of cheap money is asset bubbles, which drastically increase inequality on paper even if they fail to make the rich richer on a lasting basis (because bubbles burst). With so much money sloshing around, the equity and real estate markets are too expensive, reducing investment in the economy and hindering growth.
The real reason for today’s economic malaise and rising inequality is overregulation. This creates inefficiencies and encourages politicians to intervene in the economy for short-term, populist aims. Unfortunately, they will find cronies in the private sector, because market inefficiencies can be very profitable to a privileged few – to the detriment of business and the broader public.
Politicians and regulators should not be putting markets on a leash. They should be devising lean and efficient rules to allow free markets to do their work. Competition and innovation lead to prosperity, from which everyone benefits.
It is almost impossible to listen to politicians, intellectuals and media personalities lately without hearing the lament that liberal democracies are being threatened by populists, usually of an authoritarian bent.
At face value this assessment seems correct. But on closer examination, doubts grow about whether Western political systems can still be called democratic and liberal.
Representative democracy depends on legislators who represent the public interest (res publica), not that of a party or its ideology. In practice, however, this only works if most parliamentarians are independent people rather than professionals who view politics as a career. Unfortunately, in nearly all Western democracies, the latter predominate.
We commonly refer to parliamentarians as lawmakers. Today this is doubly true, as parliaments have evolved into factories belching forth new legislation, to the detriment of their true role of representing the nation’s long-term interests.
The political system has also evolved, as established parties do whatever it takes to uphold the status quo and maintain their grip on power. In so-called Western democracies, this has meant the established parties have become extremely populist themselves.
A myopic focus on the next election has led to strong uniformity within the political mainstream. Many people have stopped voting because they no longer see any differences. Without a real opposition, there is an absence of vigorous, fact-based debate – a vital ingredient of any democracy.
One way of stifling debate is the concept of “political correctness,” which excludes alternative thinking or raising ideas labeled as “radical.”
Meanwhile, the tsunami of laws and regulations has led to a “nanny” state that little resembles its liberal roots. The powers of government have become increasingly centralized, to the detriment of individual responsibility and autonomy which would be better invested in regions and municipalities. As is well known, democracy functions best in smaller entities, where issues are closer to home and the individual voter can still be heard.
In Europe, countries like Switzerland and Liechtenstein – which uphold strong traditions of local autonomy, direct democracy by referendum, and a militia system requiring members of parliament to earn their own livings – are not threatened by authoritarian movements.
What we now call “liberal democracy” has in fact traveled a long way down the road toward centralized bureaucracy. It is a system that cannot be trusted. No longer liberal, it cannot really be called democratic, either.
The system’s absurdity became painfully obvious during the presidential campaign in the United States. Neither of the two major parties was able to select a convincing candidate after a lengthy series of primaries. Instead, we have been offered the political equivalent of mud-wrestling – an appalling spectacle on both sides.
According to a Reuters/Ipsos poll, 66 percent of American voters are convinced that the U.S. is on the wrong track, while 22 percent think things are headed in the right direction. The situation in Europe is not much different.
What ordinary people have grasped, consciously or subconsciously, is that the current political system is populist and ridden with self-interest. Its resistance to change and decentralization is palpable, as is its hostility to notions of personal responsibility and freedom of thought and expression. No wonder voters are looking for alternatives.
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During the press conference, which followed the 21st July’s meeting of the ECB Governing Council held in Frankfurt, Governor Mario Draghi declared that the European banking system currently has a “future profitability problem” rather than a “solvency problem”. He related profitability imbalances afflicting European banks with the high amount of non-performing loans (NPLs) in banks’ assets but he also said that he felt “confident that strong supervision and robust regulation, and better communication, indeed, by the supervisory authorities, the EBA and all this, will still improve the situation and the perception in the rest of the world’s eyes”.
If we look at some stylized facts, we realize that the profitability problem of banks is serious indeed, not only in Europe but everywhere. The Wall Street Journal recently wrote of “the big-bank bloodbath”, estimating the total losses of the 20 biggest world banks (J.P. Morgan Chase & Co. Wells Fargo & Co., Bank of America Corp., Citigroup Inc., Goldman Sachs Group, Morgan Stanley, Royal Bank of Scotland PLC, HSBC Holdings, Barclays PLC, Standard Chartered PLC, UBS Group AG, Credit Suisse Group AG, BNP Paribas SA, Credit Agricole SA, Société Générale SA, UniCredit SpA, Deutsche Bank AG, Banco Santander SA, Industrial and Commercial Bank of China Ltd. and Mitsubishi UFJ Financial Group Inc.) near half a trillion dollars, as plunging share prices in the first half of 2016 have erased a quarter of their combined market capitalization, according to FactSet data. The following FactSet chart shows losses for each of the twenty observed banks:
On effectiveness (or ineffectiveness) of the ultra-expansionary monetary policies undertaken by central banks, especially the Fed, BOE, BOJ and ECB much has been written and continues to be written. Positions, amongst economists, are not aligned at all. While Keynesian economists see the monetary easing as the only possible remedy to heal the world economies hit by the crisis and stimulate consumers’ demand (George Cooper’s “pre-emptive Keynesianism”), the Austrian School of Economic has always condemned this type of stimuli, focusing on the perverse effects they generate on the real economy.
In the recent 12th Gottfried von Haberler Conference, organized by ECAEF.li and held in Vaduz (May 2016), Prof. John B. Taylor (Stanford University, USA) defined the actual world monetary environment as a “rule-free zone”, while historian Johan Norberg (Stockholm, S) described the actual financial crisis as a consequence of the “corrupting effects of easy money”. When the Euro was created, short-term interest rate decreased for peripheral countries like Spain and Ireland, whose economies ended in huge, inflated housing bubbles. Norberg reminded us as the average Spanish mortgage rate had collapsed from 18 to around 5 percent after the introduction of the single currency, and debt in proportion to income doubled for the average Spaniard between 1997 and 2006. At its peak, Spain built more than Germany, France and Italy combined. After the burst of the housing bubble, building companies collapsed and banks as well, being packed by NPLs in their balance sheets. Those same NPLs which governor Draghi accused of being the cause of the current troubles of the European banking system, without considering that the ECB is one of the architects which create this moral hazard problem in the peripheral economies.
The creation of a gigantic financial bubble is not the only consequence of the “easy money” policy undertaken by the ECB. A recent empirical paper by Borio et al. (2015)1 published by the Bank for International Settlement accelerated the existence of a correlation between the interest rate structure and banks’ net interest income and discovered that, over time, unusual low interest rates and flat term structure erode bank profitability.
In order to comprehend this second point, it’s useful to remind that the lion share of a bank’s profit comes from the interests that the bank charges for its services and the interest that it earns on its assets. The figure below depicts the average net interest margin for all U.S. banks since 1984 compared to the one-year constant maturity yield on U.S. Treasury securities, a proxy for the general level of short-term market interest rates.
To understand the relationship between market interest rates and net interest margins (NIMs) one has to consider that the optimal asset-liabilities management for a bank is synthetized by “lend long and borrow short.” This happens when the average maturity of the banks’ loans exceeds the average maturity of deposits and other type of debt. Hence, when market interest rates fall, banks’ funding costs usually fall more quickly than their interest income. As a result, NIMs rise. Over time, however, as banks repay or renew loans at lower interest rates, NIMs reduce. Thus, in the medium-to-long term, NIMs are largely unrelated to the general level of market interest rates. The point is that all this happens only under normal conditions. From 2010 something of abnormal happened, as NIMs have continued to fall while the yield on one-year Treasury securities and other market rates has been relatively stable at historically low levels, as a consequence of the ultra-expansionary monetary policies. Over this period we can observe that bank-funding costs have been exceptionally low, while the average rates of return on bank assets have fallen at a more sustained pace. If before the crisis banks underwrote loans at relatively high interest rates, during the crisis they have been obliged to underwrite new loans at lower interest rates.
In conclusion, the extraordinarily loosen monetary policy undertaken by central banks, such as the zero interest rate policy (ZIRP) associated with Quantitative Easing programs has put downward pressure on banks’ NIMs. Figure 1 shows how, over the past 32 years, banks’ NIMs have fallen by nearly -11,5%. The decline of this indicator at large banks is driven by two main factors always linked to the ZIRP environment. The first factor is due to banks’ liabilities, as funding costs at small banks strongly decreased, and accounts for the majority of the gap in the behavior of NIMs between large and small banks. The second factor comes from the other side of banks’ balance sheet. Specifically, over the last years large banks have been hit by bigger decline in the interest income that they earn on “other” assets, such as assets held for trading purposes.
*Dr. Emanuele Canegrati is a PhD at Catholic University of Milan, economist at Department of Treasury, Head Market Analyst at BlackPearlFX and Fellow of the Liechtenstein Academy Foundation.
Bericht von der 12. Gottfried-von-Haberler Konferenz, Erstveröffentlichung am 12. Juni 2016 bei “eigentümlich frei”
Am 20. Mai 2016 wurde in Vaduz, im Fürstentum Liechtenstein, die diesjährige Internationale Gottfried-von-Haberler-Konferenz abgehalten. Veranstalter der heuer zum zwölften Mal stattgefundenen Konferenz ist das European Center of Austrian Economics Foundation (ECAEF), deren akademischer Direktor Kurt R. Leube ist. Das Generalthema der diesjährigen Konferenz lautete: „Über Zentralbanken, Schuldenpolitik und den geprellten Bürger“.
Am Vorabend der Konferenz merkte der Publizist und promovierte Historiker Michael von Prollius in seiner Tischrede an, dass viele Liberale als echte Individualisten oftmals einzeln unterwegs sind. Viele Liberale würden eben – wie Sisyphos in der griechischen Mythologie – den Stein alleine den Berg heraufrollen wollen, statt die Kräfte für gemeinsame Zwecke und Ziele zu bündeln.
Unter solchen Einzelkämpfern finden sich mitunter natürlich auch geniale Geister – wie zum Beispiel Ludwig von Mises und Friedrich August von Hayek –, die dem liberalen Lager neuen intellektuellen Schwung geben. Doch auf solche Zufälle sollte – so von Prollius – nicht vertraut und gehofft werden, sondern notwendig sei eine Art von liberalem Stoßtrupp, von sich selbst ständig erneuernder Institution. Diese Institution solle stetig gute und brillante Köpfe hervorbringen, die die liberale Szene nach allen Seiten erfrischend vorantreiben …