Before the Wall Street crash in 1929 set off the Great Depression and plunged the world into economic turmoil, there were four men who towered over the global economy. Benjamin Strong, Jr., the president of the Federal Reserve Bank of New York Reserve, was a man both stubborn and domineering by nature. Sir Montagu Norman, governor of the Bank of England, was a strange fellow with a strong interest in mysticism. He preferred to travel under a false identity and suffered several nervous breakdowns over the course of his life. He once told a friend that he like to travel through walls. Emile Moreauwas the governor of the Banque de France. He was known to hoard gold obsessively and like many Frenchmen, was exceptionally proud of his cultural heritage. The fourth, Hjalmar Schacht, was president of Germany'sReichsbank and had earned hero status among his countrymen, and among some others as well, for quashing the hyperinflation that wrecked the post-WWI German economy.
These four men, their lives and careers, are discussed at great length in Liaquat Ahamed's 2009 book, "Lords of Finance: The Bankers Who Broke the World." All four central bankers were semi-mythological figures, men considered larger than life; their remarks were followed by market players as if divine pronouncements. Their closed-door consultations were termed "the most exclusive club in the world."
Yet, these men were blinded by their hubris, vanity and their complete faith in economic orthodoxy of the day, the gold standard, and their legacies are ones of tremendous damage.
Under the international gold standard system, all the currencies of the industrial countries had their value pegged to a set amount of gold. By law, all currency holders could go to a bank at any time and request to exchange currency for its gold equivalent. When times turned tough, this resulted in serious gold shortages as governments' gold reserves dwindled and individuals lost faith in country's ability to repay the gold value of its printed currency on demand.
To shore up the gold reserves necessary to maintain their currencies' value in international trade, nations were forced to restrict the amount of gold-redeemable currency in circulation.
Governments achieved this by restricting the availability of bank credit and hiking up interest rates to reduce the supply of money. But they did this just as their economies were bogging down in the global depression. Their economies were crying out for low interest rates to drive consumer demand and pave the way to recovery.
Yet the world obediently cringed before these four demigods because of their past successes and "crucified mankind upon a cross of gold," as the American statesman William Jennings Bryan put it in his famous presidential campaign speech against the gold standard.
Nowadays these central bankers are remembered and less for their triumphs prior to 1929 and more for the absolute economic mess they left behind. They created economic havoc so extreme that it spurred globe-spanning political turmoil, which in turn had to be cleaned up by such leaders as Franklin Delano Roosevelt and in marked contrast, Adolf Hitler.
The central banker who adored Ayn Rand
Fast-forward to 2006, when Alan Greenspan retired after nearly 20 years on the job as chairman of the U.S. Federal Reserve Bank.
Greenspan - "the maestro" as he was called by veteran Washington journalist Bob Woodward in his 2000 biography of the man - led the American economy through five terms at the Fed and two decades of unprecedented growth, which were punctuated by only two recessions. His long tenure in office stands in stark contrast to the four men who held the position before him during the 18 years preceding his first appointment. After his retirement, Greenspan, a known acolyte of novelist and libertarian philosopher Ayn Rand, was termed "the best central banker in history."
He didn't get to keep that soubriquet for long.
Two years later the U.S. housing market tanked, as did mortgage-backed securities, driving the global economy towards the brink. The collapse of the giant investment bank Lehman Brothers merely marked a turning point. The real culprit was the regime of low interest instituted by Greenspan throughout his tenure: It is this policy that has been held responsible for creating the housing bubble.
"I made a mistake," Greenspan admitted during a Congressional hearing in Oct. 2008, saying that his adherence to free market fundamentalism had falsely led him to believe that markets could regulate themselves better than government rules or watchdogs. "I had been going for 40 years with considerable evidence that it was working very well."
Greenspan's successor at the Federal Reserve, Ben Bernanke, had to act quickly in 2008 to save both the U.S. and world economy. He started with slashing the Federal Reserve interest rate to zero, and pumping in vast sums of government capital into the markets to stabilize the financial system. This process has become known as a quantitative easing.
As his guide, Bernanke studied the catastrophic response of the previous generation's central bankers during the Great Depression. In 2009 Time Magazine named him Man of the Year for 2009 for his early success in preventing a complete meltdown in U.S. financial markets. Also, despite its generally conservative image, the European Central Bank also implemented drastic measures during the financial crisis that, according to economist Satyajit Das, made it more "leveraged than Lehman Brothers."
Now, despite Herculean efforts in the U.S. and Europe to promote economic recovery, they are drowning in debt and have no clue how to repay.
Worse, after pouring trillions of dollars into the global financial system both the U.S. and European economies continue to stall at every chance for recovery as their central bankers have gone through almost the entire arsenal of policies at their disposal.
Got any policies left? No?
During the past few months, just like in the 1930s, the world has become disillusioned with the central banks. Many critics have begun to say loud and clear that perhaps these financial pillars may have actually caused more harm than good.
To many it seems as if the massive bailouts and emergency loans to banks they granted benefited mainly the bankers themselves, and central bank employees who sought jobs at major financial concerns in the private sector. But the public at large has been left out in the cold.
Once interest rates had fallen to depths from which they couldn't descend any more, the central banks became impotent. The only policy remedy left was to increase the money supply by running the mints overtime, though they know the terrific risks they're running. The only other palatable solution is to issue stern warnings to the financial markets.
In January Mohamed el-Erian, CEO of the biggest mutual-fund management company in the world, Pimco, wrote an opinion piece in the Guardian that savaged the central banks.
"More than three years after the global financial crisis, the world still has a nasty plumbing problem,"Erian wrote. "Credit pipes remain clogged." But the central banks' ability to clear the pipelines was weakening, which in itself posed yet another set of risks for western economies blocked by too little growth, too much unemployment, deepening inequality, and debt in all the wrong places, he summed up.
After throwing billions of dollars at the problem without any significant effect…"the central banks have been unconventional bridges to nowhere," he concluded.
Last month Erian continued his assault on the central banks in a speech at the St. Louis Federal Reserve. He claimed the central banks were incapable of repairing the global economy because the key issues facing it are not monetary in nature and, therefore, cannot be solved with simple interest rate adjustments.
The problems facing the global economy today are much more complex, Erian explained. They have to do with problems in education, employee training and economic realignment from top to bottom– things for which the central banks have no relevant expertise.
The steps being considered today by the Fed, the European Central Bank and the Bank of England – more government intervention in the markets and more quantitative easing – are unsustainable, he says. They'll just exacerbate the damage already done to the global financial system, markets and the pension funds that are invested in them.
"In the last three-plus years, central banks have had little choice but to do the unsustainable in order to sustain the unsustainable until others do the sustainable to restore sustainability!" Erian told listeners.
Despite setting out on a fool's errand, Erian noted, the central banks feel they must do something to roll back the notion that they are ineffectual in combating the crisis. He used his speech at the St. Louis Fed as an opportunity to call upon central banks to back away from the spotlight and give up their paramount position in economic policymaking to let other government agencies play a part.
A convenient scapegoat
Withering criticism of central banks is nothing new by historical standards. There is no more convenient political scapegoat during economic crisis.
Bernanke was on the receiving end of quite a few harsh words when he decided to keep interest rates incredibly low from 2008 and promised not to lower the rate further until 2014 at the earliest.
The European Central Bank also received quite a lashing for maintaining its conservative monetary stance and ostensibly not taking drastic enough steps to address the debt crisis in Europe. Yet the ECB had in fact implemented several key steps including pouring 530 million euro into 800 different European banks in March. It even dealt with some sharp criticism from amongst its own constituent members. The Deutsche Bundesbank, the German central bank, was not keen on bailing out faltering banks with new loans that were unlikely to be repaid in full.
Beyond their role in economic affairs, central banks are often accused of corruption and opacity. Their policy meetings are held behind closed doors and they do not reveal the amount of money they disburse from the public purse to shore up failing concerns. The public is left with the impression that a small coterie of bankers is managing the public's economic affairs for its own benefit; then when economic crisis arises, the public must foot the bill for the misdeeds of the elite.
The Federal Reserve Bank waged a quite vicious legal battle with Bloomberg News last year after the financial news agency demanded that the bank disclose how much money it loaned companies during the financial crisis bailout and who exactly received the money. Bloomberg prevailed and the relevant documents were disclosed to the public.
It turns out that over the course of the financial crisis and its immediate aftermath the U.S. Federal Reserve lent $16 trillion to various banks and corporations in the U.S. and around the world.
"There needs to be a comprehensive reform of the Federal Reserve so that it serves the needs of working families and not just those of CEOS on Wall Street," said Democratic Senator Bernie Sanders in a strongly-worded attack in October.
Then there are apparent conflicts of interest. In Israel, the past supervisor of banks for the Bank of Israel, Rony Hizkiyahu, was hired as chairman of the First International Bank of Israel's in a move that caused more than a few eyebrows to rise. The U.S. as well has had numerous former Fed employees hired to plum jobs at commercial banks or investment companies, trading on their privileged insider knowledge of the Fed and connections with people there that only a few can claim to possess. For example, Susan Bies had served on the Board of Governors for the Federal Reserve System; the Fed's representative at the Financial Stability Forum an international group of central bankers and finance ministers; and according to Forbes magazine "led the modernization process for the Basel agreements at the Federal Reserve." She wound up joining the board of directors at the Bank of America.
Laurence Meyer was also a senior Fed bank employee before he left in 2002 to return to the firm he helped found, Macroeconomic Advisors, which produces economic forecasts. His firm in particular has employed over the years several other former senior Fed employees. Some of these employees were active practitioners of the "revolving door" philosophy and returned to jobs at the Fed after their stint at the company before proceeding to return to the private sector yet again.
"The Federal Reserve has tried over the years to find means to strengthen the transparency of its activities and I think it has made great progress," said Bernanke recently while addressing the public release of some of the documents and financial figures belonging to the Reserve. "We have become a very transparent central bank."
Bernanke's counter-attack reminded many in the U.S. that the largest domestic banks that were bailed out during the financial crisis because they were "too big to fail" are only large and stronger today. They are still free to do as they please without any serious regulation.
Ron Paul: Fed's running a Ponzi scheme
If the centrals banks are opaque by their very nature and have lost their relevance due to squandering massive amount of capital on aid for financial institutions without achieving positive results for anyone beyond their own employees, who needs them?
Republican Congressman Ron Paul has called for the repeal of the US Federal Reserve Act for years now. He also published a book called "End the Fed" in 2009.
An extreme libertarian, in his book Paul advocates repealing the Federal Reserve and blames it for the increasing inflation, unemployment and the explosion of U.S. government debt during its existence.
"If you and I were to print money like the Federal Reserve, we would both be going to prison," Paul told comedian and Daily Show TV host Jon Stewart in a 2009 interview. "The Federal Reserve is running a Ponzi scheme."
In his book, Paul adds, "All across the U.S., people are gathering outside the offices of the Federal Reserve to protest against the power, secrecy and the behavior of the bank and calling for its dissolution. Their goal isn't reform, it's a revolution." In place of a central banking system, Paul advocates a return to the gold standard of old.
Despite his unsuccessful run for the Republican presidential nomination, Paul has become a respected figure on the right. One of his many admirers, Texas resident Daniel Williams, has developed an online game where Paul's characters must fight to dissolve the Federal Reserve. The game has 50 different levels – one for each state in the Union- which Paul's character must complete to achieve victory. Gamers must also beat 13 arch-villains in the game - bosses in video game parlance- each representing one branch office of the Federal Reserve as they advance through the game.
However, maybe the real problem with the U.S. reserve banks is that they seek to maintain their own independence. That is what Paul McCulley – a research fellow at the Global Interdependence Center think tank that promotes free trade and past senior partner at PIMCO – has claimed.
"We must rethink monetary and fiscal policy [in this country] and the mix between them," said McCulley. The doctrine of central bank independence, which has really become a principle of faith, does not always stand up to the test of reality, especially as the world continues to change."
"The time has come that other agencies, both in the public and private sectors while step up to the plate and address the problems," Erian wrote two weeks ago. He feels other agencies would be better suited to removing the obstacles blocking economic recovery. "Deep in their hearts the [central] banks know that they don't have the tools to deal with the challenges that face them today," he wrote.
They don't know how to train workers, improve the mobility or flexibility of the labor market, and they have no influence over the educational system. "Yet these are the challenges that we are must face if we wish to prevent the situation where the curse of unemployment becomes a permanent structural feature of our economy and even more difficult to solve," Erian summed up.
It appears that just like in the 1930s, the downfall of the central banks today is due to their blind adherence to the economic orthodoxy of the time, which didn't fix the crisis – and in practice helped cause it.
In reality, the purpose of the central bank is to preserve the status quo in the financial system at all costs and defend its stability. However, when the world is standing at the precipice it needs a driver who can divert the steering wheel left or right and won't stubbornly stay the course.
To be fair, nobody has the kind of challenges that central bankers must confront today. The central banks find themselves in the eye of a political storm that isn't directly tied to their mission but makes it more difficult for them to operate with a free hand. They were given an economic crisis that rendered most of the tools in their possession irrelevant and contravened years of accepted economic theory.
True, some of these bankers bear partial responsibility for their role in creating the crisis but at times of economic downturn it is too easy and tempting to attack central bankers, particularly because of their penchant for operating in secrecy.
Also to be fair, Ben Bernanke was walloped for "activist" tendencies when he bailed out the financial world by pumping into it so much liquidity that the Fed's balance sheet ballooned to $3 trillion. Bernanke found himself at the center of strident controversy that didn’t subside until his announcement of a third quantitative easing program (aptly named QE3), despite Republicans like Texas Governor Rick Perry who distanced himself from the move and labeled Bernanke's measures as equivalent to treason. Bernanke was damned if he did, damned if he didn't.
Over the entire duration of the financial crisis the central banks have been told to abandon their inveterate conservatism and to implement extreme measures to contain and extirpate the contagion spreading through the economic system. The result was a lackluster showing that mainly served to reveal their limited independence from the political establishment.
What is the future of the central banks? It will be a busy one, wrote senior Financial Times columnist Martin Wolf: They're expected to provide both monetary and fiscal stability and everything they do will be controversial. Everybody hates bank bailouts, but what's the alternative?
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