Tuesday, October 18, 2016
We can agree on 2 of 3 - Jury out on central banking
-Will Rogers 1920
The modern financial world could not exist without effective central banking. The foundation of this core invention is a trust in banking; a trust that a paper claim can be used as a medium of exchange and a store of value; a trust in the ability to obtain liquid funds from the banking system; and a trust in the effective control of money by policy-makers to help generate economic growth. So what is happening to the great invention of central banking? There is a decline in central bank trust. It is not that central bankers are untrustworthy, but that they do not know what are the right policies to ensure growth.
Currently, central banks with just a few exceptions are easing in an effort to promote growth. Nevertheless, this growth is not based on a stable set of rules for policy, forming a better system of governance, or an invention to promote productivity. Rather central banking is now based driving real rates negative in order to force more risk-taking by investors and more borrowing by debtors to ultimately generate new investment.
Central banks try and corrupt the time value of money in order to pull consumption forward. We should not be surprised that monetary policy is working to generate more growth, but it should be surprising to expect that monetary policy can bend the long-term trend in growth higher from former trends. Sustained growth is a more complex problem than forcing financial behavioral changes.
Central banks will affect discount rates and financial market valuations, but it is less clear whether the top line growth of revenue will be affected once rates reach such a low level. More emphasis is placed on future growth when discount rates are low so there is a greater emphasis on productivity and the future real economy. If that picture is not bright, the discount rate does not matter.
The invention of central banking works best when creditability is high. If trust in the central banker is reduced, investments will not be made. Trust comes from certainty in policy not in banking experimentation. Trust comes from knowing the policies of today will be used tomorrow. One degree of uncertainty is reduced when this is known. A core issue for effective financial markets is that investors know that the great invention of central banking is not broken.