Markets challenge central banks
By John Browne
Published: Saturday, Aug. 31, 2013, 9:00 p.m.
The Federal Reserve's initiatives to stimulate the economy — including its low interest rate policy, monthly bond purchases and support for government bailouts — may have stretched market manipulation almost to the breaking point.
Combined, these have led the Fed to create some $3 trillion in synthetic dollars in an “experiment” of unprecedented size and scope. The apparent success in averting a collapse of the financial system, recession and depression created a degree of hubris.
It inspired the Fed, as the international reserve currency's central bank, to take its philosophy to other key troubled economies like those of Japan, the United Kingdom and the European Union, despite German resistance.
As the low-interest program continued, it was reinforced by “forward guidance,” through which central banks committed to interest rate repression for years to come. After some five years, these programs are being evaluated by the Fed and by the markets. The results look bad. Rising interest rates indicate markets possibly are challenging central banks.
In two respects, the Fed's policies have been an undoubted success. First, Wall Street was saved. But it has not been reformed. Too-big-to-fail banks have grown even larger and are engaged still in massive operations imposing inherent risks on depositors and taxpayers.
Secondly, time was bought, albeit at a vast cost to future generations. Politicians have failed, however, to cut big government and restructure their economies.
The Fed's programs appear to have failed or succeeded marginally at best, pumping financial markets with speculation.
Two Fed economists — Vasco Curdia of the San Francisco Fed and Andrea Ferrero of the New York Fed recently authored a report: “How Stimulatory Are Large-Scale Asset Purchases?” They estimated that by 2012, the Fed's bond purchases had added only 0.13 percentage points to the United States' real Gross Domestic Product. Furthermore, they concluded, without forward guidance, the contribution to the GDP would have been a paltry 0.04 percent.
The Fed's St. Louis branch says the Fed's low-interest rate program has cost fixed-income investors roughly $700 billion over the past five years. Following increased taxes and Obama-Care, that may be one key reason why the Fed's $85 billion in monthly Treasury bond purchases failed to inspire consumers to spend.
But when Fed Chairman Ben Bernanke hinted at the possibility of a tapering of the bond buying program, markets went into a tailspin. The question is not if the Fed should end bond purchases, but when.
For 99 years, the Fed has had undisputed control of short-term lending rates. But in London's vast offshore free market in greenbacks, the rate banks charge each other — a benchmark for other loans — has started to rise. Does the rise in the rate, combined with a pending change in Fed governors, indicate the beginning of a free-market challenge to central bank interest rate repression? If so, it could have dire consequences for currencies and the debt of spendthrift and developing nations.
John Browne, a former member of Britain's Parliament, is a financial and economics columnist for Trib Total Media. Email him at firstname.lastname@example.org.
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