Misconceptions About Central Bank Policies

On occasion of an address to economists at a conference in France, Bundesbank  president Jens Weidmann reminded the audience that 'the ECB cannot solve the crisis', because it is due to structural reasons and therefore requires structural reform. Weidmann rightly fears that governments will begin to postpone or even stop  their reform efforts now that the ECB has managed to calm markets down. In a Reuters article on the topic, a number of people are quoted remarking on ECB policy. What is so interesting about this is how far removed from reality general perceptions are when it comes to judging current central bank policies.


“The European Central Bank cannot solve the euro zone crisis, Bundesbank chief Jens Weidmann told economists on Sunday, pressing the bloc's governments to get their economies in shape and tighten their fiscal rules.

Weidmann addressed an economists' conference in Aix-en-Provence, southern France, only three days after the ECB broke with precedent by declaring that it intended to keep interest rates at record lows for an extended period and may yet cut further.

"Monetary policy has already done a lot to absorb the economic consequences of the crisis, but it cannot solve the crisis," Weidmann said in his speech. "This is the consensus of the Governing Council. The crisis has laid bare structural shortcomings. As such, they require structural solutions."

Weidmann, widely recognized to be the most hawkish member of the ECB's 23-man Governing Council, does not want the bank to intervene too strongly in tackling the bloc's economic crisis, thereby allowing governments to soft-pedal reforms.


"The euro zone is on the mend, it must be at peace, protected, be allowed to heal," Coeure told the same conference on Sunday to explain the ECB's decision to issue such forward guidance, while urging governments to tackle structural problems.

The EU's top economic official, Olli Rehn, welcomed the ECB's move, saying the step – taken in response to turbulence caused by the U.S. Federal Reserve's plan to slow monetary stimulus – was needed to preserve recovery in Europe. "The United States and Europe are at different points of the economic cycle. While the U.S. has a more restrictive approach, Europe needs to continue with a more accommodative policy," the EU monetary affairs commissioner said.”


(emphasis added)

So according to Olli Rehn, because the US and the euro-zone are 'at different points in the economic cycle', the Federal Reserve is 'more restrictive' and the 'ECB more accommodative'. Let us see if that is actually true.



Fed Credit

Federal Reserve credit outstanding  plus 12 month rate of change. The US monetary base has grown at a 46.3% annualized rate over the past quarter and 14.2% over the past year (data and chart via Michael Pollaro) – click to enlarge.



Now let's compare this to the growth in ECB credit to see if the ECB is indeed 'more accomodative' than the Fed at the moment. 



ECB credit

ECB credit outstanding plus 12 month growth. The euro-zone's monetary base has been shrinking at a 41.1% annualized pace over the past quarter, and is down 10.1% year-on-year- click to enlarge.



In short, the idea that the Fed is 'more restrictive' and the ECB 'more 'accomodative' is completely contradicted by the facts pertaining to the shared continuum we all dwell in, a.k.a. 'reality'. The Fed is currently inflating at breakneck speed, while the ECB is contracting central bank credit. The notion that the Fed is 'tighter' than the ECB is a fiction, based on what people at the central banks are saying, not on what they are actually doing.


Weidmann's Fantasies

As Jens Weidmann's additional remarks showed, he is apparently hoping that central banks can really become separate entities that worry solely about the value of the currency instead of being the nexus and handmaidens of the unholy alliance between the State and the banking cartel. In fact, the ECB's statutes indicate that the ECB was originally supposed to be such a central bank, but as we have seen, ways around the limitations imposed by the statutes are constantly found as soon as perceived emergency situations arise. Said Weidmann: 


“In addition to stronger rules, we need to make sure that in a system of national control and national responsibility, sovereign default is possible without bringing down the financial system. Only then will we really do away with the implicit guarantee for sovereigns."


The Bundesbank chief also called for euro zone governments to sever what he describes as the "excessively close links" between banks and sovereign governments, saying that European banks hold too many of their own governments' bonds. "This is because banks do not have to hold any capital against their government debt, as the risk-weight assigned to sovereign bonds is zero. To counteract excessive investment in sovereign bonds, Weidmann believes that the capital rules need to be changed to take account of risk and exposure levels.

"Only then will banks be able to cope with the repercussions of sovereign default."


(emphasis added)

In short, Weidmann wants to end the three card Monte, whereby commercial banks buy the bonds issued by governments because they don't have to put any capital aside for the purpose, which bonds they then can in turn pawn off to the central bank for refinancing purposes. They do this of course in exchange for enjoying the legal privilege of fractional reserve banking, which allows them to create money from thin air. Throughout antiquity, the practice of banks using demand deposits belonging to customers for their own business purposes was deemed to be fraudulent. The modern-day legal notion that a demand deposit is a 'loan to the bank' is likely the result of legal confusion that arose as a result of the medieval usury ban (for details on this see the paragraph on 'Two Different Types of Contracts').

Weidmann wants to see the connection between banks and sovereigns severed, a connection that has been fostered by governments over many centuries in order to enable them to spend more than they take in through tax revenues.

We still remember clearly that Nicolas Sarkozy, the former president of France, openly called for banks to engage in the sovereign bond carry trade shortly before the ECB granted its LTROs. The banks didn't need to be told twice. In Spain and Italy, where sovereign bond yield had shot up to reflect growing default risk as well as a growing risk that these countries would be forced to leave the euro, commercial banks bought record amount of sovereign bonds over the ensuing 18 months.

We would also remind in this context that after several bank 'stress tests' were conducted by the EBA (the European Banking Authority – the markets didn't really trust any of the stress tests, and rightly so as the insolvency of Dexia later showed), there was talk that sovereign debt would no longer be regarded as 'risk free' by regulators. This idea has been quietly dropped in the meantime. In short, it is practically certain that Weidmann's plea is going to fall on deaf ears.




Charts by: Michael Pollaro




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