There have been three great inventions since the
beginning of time: fire, the wheel, and 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.
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