Drinks Are Free as Bartenders Refill Punchbowl: William Pesek
By William Pesek – Oct 6, 2010
It has been 13 years since the Bank of Japan was freed from the clutches of politicians. What has it done since? Cut interest rates to zero and left them there.
If that’s your definition of “independence” then it’s different from mine. Sure, the BOJ managed to boost rates here and there — even getting them as high as 0.5 percent. It has since relented. This week, it bowed anew to politicians’ demands to lower its 0.1 percent benchmark toward zero.
Japan doesn’t cut rates. It shaves them. This predicament puts Japan at the center of a dangerous trend: the death of central-bank independence. The ramifications for credit markets will be huge.
Six months ago, it was possible to say we’re in crisis, extreme measures are needed and central banks are doing their part. Now, we must accept that ultra-low borrowing costs will be with us for a while because governments will make sure of it.
Take the world’s other main monetary authorities. In Washington, Ben Bernanke would be called to Capitol Hill the moment the Federal Reserve even hinted at reining in liquidity. Calls for his resignation would pave the way for legislative efforts to install a more agreeable Fed chairman.
Jean-Claude Trichet wouldn’t have one angry government looking over his shoulder if the European Central Bank considered tighter policy. The ECB president has 16 member nations to think about. And, of course, Governor Zhou Xiaochuan has no independence at the People’s Bank of China.
The BOJ may be the vanguard of a fresh round of central- bank action to prop up the global economy as recoveries falter. It’s a reminder that the lines between central bankers and politicians have rarely, if ever, been fuzzier. They are about to get even blurrier as the effects of massive fiscal stimulus fall short and politicians get desperate.
Yet with all the calls for a return of free-market fundamentalism and budget cuts in the U.S., the Fed won’t have much latitude to move away from near-zero rates.
Our romantic notions about autonomous central bankers have long been a bit much. Take the Fed under Alan Greenspan. In December 1996, Greenspan spooked investors with questions about “irrational exuberance” in stocks. Politicians like then- Senate Majority Leader Trent Lott went absolutely ballistic.
Greenspan left asset prices alone after that — to disastrous effect. If only he displayed a bit more independence, the bubbles that inflated and burst in the early and late 2000s might not have been created.
Central-bank freedom is steadily being curtailed. Concerns that the global economy will follow the BOJ’s trajectory are pointless. The world’s main monetary powers already are like Japan. Just imagine the outcry Bank of England Governor Mervyn King would face if he raised interest rates. It would be politically impossible as lawmakers try to cut spending.
And like Japan, free money isn’t getting much traction. Japan’s rates have been near zero for 15 years and the country is still fighting deflation. The Fed is toying with another round of quantitative easing as hundreds of billions of dollars of public spending fail to lower the U.S. jobless rate.
Notice that there’s less and less talk of exit strategies in markets. Investors are wondering how policy makers can possibly begin soaking up all the money with which they have flooded the globe, while governments are so on edge.
Hand in Glove
In Japan, a great premium is placed on fiscal and monetary authorities working hand-in-glove. The lines get mighty blurry when central banks start gobbling up private-sector assets such as corporate debt, commercial paper, exchange-traded funds and real-estate investment trusts.
Things get messy as central bankers get creative with their roles and unwinding the tentacles will be difficult. Lawmakers whose supporters will get hurt when central banks withdraw liquidity may cry foul. Credit markets could seize up again. New bubbles might appear and moral-hazard risks could increase. Once growth returns, it will have an artificial quality based more on monetary stimulants than healthy demand.
Replacing old bubbles with new ones always ends badly. Even more so than a year ago, central bankers are acting like reckless bartenders enabling markets. Doling out more and more booze gets politicians off your back, yet the hangover will be nasty. The drinks are free, but the fallout won’t be.
Low rates are taking the onus off governments to fix financial systems. The half-hearted nature of reforms in the U.S. is but one example. The new Basel III regulations for bank capital requirements give them as long as eight years to comply in full. Lots can go wrong in markets between now and 2018.
There was a time when central banks could get away with painful and politically unpopular measures. We don’t live in such a time, though, and the nature of markets will never be the same. That goes, too, for the nature of tomorrow’s bubbles, which will be more spectacular than yesterday’s.