Spare a thought for the bureaucrats stuck with one of the most important, and miserable, jobs in the world.
- By Felix SalmonFelix Salmon is the finance blogger at Reuters.
Central bankers have always been important, but never since World War II have they been more critical than they are now. The bright sparks who invented a second global reserve currency in Europe are now charged with keeping it in one piece; meanwhile, the stewards of the first global reserve currency in the United States are resorting to increasingly unorthodox measures as they find their old arsenal empty in the face of a crisis that they — and the banks they supervise — helped create. On Wednesday, six central banks around the world, in a coordinated action, announced they were ready to open their windows wide to any bank which wants to borrow money from them at ultra-cheap rates. It was the latest attempt to get to grips with a series of global crises where central banks have, in general, found themselves very much on the back foot.
It’s not a comfortable place for central bankers to find themselves. U.S. Federal Reserve Chairman Ben Bernanke, recently retired European Central Bank President Jean-Claude Trichet, and People’s Bank of China Governor Zhou Xiaochuan aren’t politicians: They don’t, as a rule, like the limelight. (Bernanke’s famous predecessor, Alan Greenspan, was an exception, of course, and he’s paying for that now.) In general, central bankers are most happy when they’re gathered around a conference table, debating whether to raise short-term interest rates or lower them. Trichet and Zhou are career technocrats, while Bernanke is an academic who once chaired Princeton University’s economics department.
Occasionally, however, if an economy gets really bad, as it is now, central bankers are thrown into the limelight as lenders of last resort — the place to go for a loan when nobody else is willing to lend. For them, it’s uncharted, uncomfortable territory.
That, basically, is what has been happening in the most recent downturn. In the United States, the Fed under Bernanke printed money and used that money to buy Treasury bonds. It was an untested and unproven strategy, and it carried substantial risks. "Quantitative easing" (QE), as the practice is known, is prone to distorting financial markets and driving up the price of stocks and bonds without having much, if any, visible effect on the real economy. Indeed, that seems to have happened.
During the first round of QE from 2009 to 2010, the stock market rose more than 50 percent; the second round saw another strong market rally. Both involved investors buying up hundreds of billions of dollars’ worth of Treasury bonds, raising their price.
For Milton Friedman’s 90th birthday, in 2002, Bernanke gave a speech in which he promised, on behalf of central bankers everywhere, never again to let the world fall into a depression. Those words ring hollow today — not because Bernanke made bad decisions, but because it turns out that he simply didn’t have the ability to prevent another meltdown after all. In the event of a major global financial crisis, it turns out, central banks can only do so much. Right now, their armories are looking decidedly empty in the face of a problem that has never been more daunting. Central banks can cut rates all the way to zero and even buy longer-dated bonds, but the help from that may not come soon enough.
Additionally, Bernanke’s huge problems on the rate-setting front pale in comparison with what Trichet and his colleagues at the European Central Bank (ECB) have been being asked to do to save Europe: They have to reinvent the practice of lending money as a last resort.
Historically, central banks have lent money to banks, and because central banks are also bank regulators, they could be strict about how that money was to be used. (No big bonuses! No large dividends!) Today, however, the ECB is being asked to act as lender of last resort not to Europe’s banks but to its governments. If Portugal or Ireland can’t borrow money anywhere else, can’t they just cover their deficits by borrowing from the ECB?
The problem with lending to sovereign governments is, well, that they’re sovereign — no central bank can tell an independent nation what to do with its money. Additionally, because loans to sovereigns are unsecured, there’s a real risk that the lender of last resort could end up losing a ton of money if the country in question found itself unable to repay that loan. Losing money is not something in any central bank’s playbook, and the ECB, in particular, seems very unwilling to risk it. But if Europe is to shore up its troubled governments, from Ireland to Italy to Greece, then it’s going to need to use ECB money somehow.
As Italy’s Mario Draghi takes the helm from Trichet at the ECB, his biggest challenge will be to work out whether and how Europe’s central bank might be willing to bail out its troubled sovereigns. The stakes couldn’t be higher: If he can’t pull it off, the whole continent could fall apart — and mark an ignominious end to a project that Trichet himself devoted much of his life to.
In China, Zhou — one of the most sophisticated and internationally minded Chinese bureaucrats — is facing a similarly vexing, if different problem. With China’s holding at least $200 billion in U.S. Treasurys — more than anyone except the United States — Zhou is struggling to decide how long, or even whether, to keep that holding as the U.S. economy continues to sputter.
One thing the U.S. and European central banks have in common is this somewhat paradoxical problem: In many ways, the biggest risk is that they won’t be bold enough. In the United States, especially, the Fed has become highly politicized by the Tea Party and others — and that’s dangerous, when it has to do radical new things in order to save the economy.
Central banks are doing one thing right, however. In the wake of the financial crisis, central bankers around the world have embarked on a huge new project: revamping the international rules governing banks so that never again will the world see a financial crisis like that of 2008. The effort has a name — Basel III — and attracted a brief flurry of attention at the end of 2010, when, after a lot of discussion, the world’s central banks largely agreed on the core measures of capital and liquidity that big banks would henceforth need to hold. In many ways it’s this, rather than easing or government lending, that will prove to be the single most important development in the recent history of central banking. If it works, it will help keep the world’s banks under public control; if it fails, then we will surely face ever larger and more frequent financial crises in the future.
It will take a while for Basel III to come into effect, even under a best-case scenario. Some deadlines don’t arrive until 2019 — which means that the most important central bankers of all, as far as the world’s long-term economic future is concerned, could end up being not Bernanke and Draghi or even Zhou, but rather the midlevel technocrats charged with implementing Basel III. They’re utterly unaccountable to anybody and fly well below the political radar. The rest of us have no choice but to simply trust that they’re good at what they do.