William Miller, a former Fed chairman in the 1970s was known to have joked that 23% of the US population thought the Federal Reserve was an Indian Reservation, 26% thought it was a wildlife preserve, and 51% thought it was a brand of whiskey. On that basis the ECB might be confused with the England Cricket Board and the BoJ as Balance sheet of Jenga.
Miller shouldn’t really have been one to joke – his tenure at the Fed lasted only seventeen months after he flagrantly lost control of inflation, to be ‘promoted’ to the role of Treasury Secretary and replaced at the Fed by Paul Volker – the rest as they say, was history.
We are back at a Volker moment of sorts. Only ‘sorts’ because to Miller’s intuition, it seems to me that the vast majority of people have no idea of the chaos that central banks are sowing in their lives – having pumped excessively cheap money into the economy, trapping new home buyers and then as inflation took off, taking a hawkish turn and raising rates aggressively in an attempt to undo their prior mistake (see our earlier note Pantomime to Farce).
In this context, it strikes me that there is very little public sense of what central banks are doing, and of the accountability of the actions, views and forecasts of the major central banks. Strangely though appropriately, this period of monetary tightening is also accompanied by some introspection as to what the role of central banks is.
For example, in a recent speech at Sweden’s Riksbank, Fed Chairman Jerome Powell stated that the Fed’s mandate did not encompass the role of a climate policymaker. His comments likely reflect a debate in the US, predominantly amongst Republicans as to the extent to which ESG (Environment, Social and Governance) driven policies should be pursued by institutions and investors.
Powell is in my view, correct in the view that the role of central banks needs to be tightly defined, though incorrect if he assumes there is no link between the policies of central banks and climate damage (curiously excess temperature readings and world debt to GDP have risen in tandem since the time QE (quantitative easing) begun). Relatedly few central bankers return to the perspective that a significant opportunity to ‘reset’ finance was missed in the heat of the global financial crisis.
Powell’s attempt to frame the Fed’s role comes at a time when the role of central banks in the political economy is enormous. As they have come to the rescue of various crises – that of low growth in the US, the structural deficiencies of the euro-zone and the economic side-effects of COVID, their role has burgeoned.
Central bank mission creep appears contagious – Janet Yellen positioning the Fed as the ‘cure’ for long-term unemployment, Christine Lagarde as the solution to climate change, and the outgoing Bank of Japan Governor Kuroda positioning the BoJ to swallow the entire Japanese financial system.
What is increasingly absent is a sense that fiscal policymakers are willing to both channel and offset the power of central banks.
First, for crucial policy issues like climate change and wealth inequality, monetary policy is a powerful motivating force but too broad based to have real policy relevance. Here fiscal policy makers need to channel the impact of monetary policy through instruments (such as the issue of green bonds) so that capital is directed to viable green technology projects and similarly to curb its effects on wealth inequality through taxation. Europe is much better than the US in these regards. Where Europe falls down (apart from capital markets and banking union), is in the way individual governments set fiscal policy with respect to the common monetary policy.
The omnipotence of central banks also means that they are an important benchmark for the quality of institutions, and for public policy leadership. For instance, that the ECB’s view on inflation and the outlook for the economy have very little credibility is not a great thing.
Far, far worse, in September 2021 it came to light that very senior Fed officials had been actively trading securities – something that would be unimaginable to most investment bank compliance officers. Interestingly, the moment that the Fed introduced new policies to oversee and effectively stop trading by Fed officials (December 2021 /January 2022) marked the top for equity markets and the onset of a hawkish turn in US monetary policy.
Ideally, this should never have occurred, especially at a time when so many other American institutions – from Congress to the Supreme Court – have been under attack, and it is my sense that most of the previous holders of the Fed Chair would have resigned in such circumstances.
So, if central banks need to do better on the ‘G’ part of ESG they will soon be confronted with the lure of geopolitics. To continue the thread that David Skilling and I opened up at the start of the year in ‘War by Other Means’, and if readers don’t mind, returning to page 267 of The Levelling …
‘One dimension that may complicate the need for less central bank intervention and diminish their independence is the quest by the large poles for financial dominance over each other. Central banks could become a vital instrument in such pursuits. Echoing Carl von Clausewitz’s view that “war is the continuation of politics by other means,” in a multipolar world central banks could become the monetary battleships of the large regions, with currency wars shadowing trade wars.
Indeed, the epidemic of countries sanctioning each other in 2018 (Saudi Arabia sanctioning Canada, the United States sanctioning Turkey, Russia, and China, for instance) suggests that finance is a key part of the geopolitical arsenal. Against this backdrop, governments may be tempted to allow central banks to take on a more strategic or geostrategic role than the “mere” economic function they play today. For the United States and Europe, this compulsion may well grow. Financial globalization is the only area of globalization where the United States is truly dominant, and using financial architecture to entrench its dominance is a compelling strategy.
In this context, I think that once this rate hiking cycle is over, the major central banks, as well as the minor ones like the PBOC, will spend more time thinking how they can expand the circulation of their currencies (the US in the Middle East, Latam and with swap lines to Asia, China in Africa, and the euro-zone in Eastern Europe and North Africa) and how they can use their monetary tools against other economies.
Before that, the central banks (note there is an important Fed meeting next week) may have to negotiate a financial crisis – every US rate cycle since 1970 ended with a financial/market crisis. The outcome of such a crisis will have a bearing on the strategic competition facing the world.
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