Central Banks: An Ineffective Entity in an Economy
"You are a den of vipers and thieves." - President Andrew Jackson, 1834, on closing the Second Bank of the United States.
The central bank is entrusted with the most important element of an economy, the price of capital, through its exercise of interest rate policy. An assumption is commonly formed in the modern era of finance that the central bank is in constant control of the economic situation of the day, and possesses a blueprint for handling most any time of upheaval through its exercise of interest rate policy, as well as other monetary interventions. With a nearly hundred year resume (longer if you count the previous iterations in the Banks of the United States), in the case of the U.S. Federal Reserve, it has been pretty clear that the central bank does not have a blueprint for times of upheaval (or even times of calm for that matter), and certainly has not been in control during recent times of economic turmoil. On the contrary, often the central bank's interventions make circumstances far worse, an argument to be found at the heart of this article: the central bank is an ineffective entity in an economy, and modern monetary theory has caused an economic malaise which will not be remedied by any banking action.
In fact, normalization of interest rate and banking policy is nearly impossible at the present time; the toothpaste is out of the tube, so to speak. We'll get to that later.
Let's begin by discussing the reasoning for a nation to have a central bank in the first place. The modern idea behind a central bank is that it essentially acts as the accelerator and braking pedals for an economy through its management of interest rate policy, keeping prices stable and the economy functioning at an even keel. If an economy is in danger of over-heating, with the threat of inflation looming as a result of runaway economic growth, the central bank steps on the metaphorical braking pedal by raising interest rates, which increases the cost of capital, and in theory results in a contraction of the money supply, preventing inflation. The 'braking pedal' has fallen increasingly out of favor, as it usually leads to a drop in asset prices, something that is unwelcome in modern times. Continuing, an economy which is faltering would need the 'accelerator pedal,' as the central bank would lower interest rates to encourage credit expansion and, in theory, economic activity. Lately, the economy has been operating with the 'accelerator pedal' activated for nearly a decade, leading to asset price valuations which are stratospheric. We are all currently living in a time of a global asset bubble of unfathomable proportions. More on that later. In a nutshell, modern economics is devoted to the idea that the central bank will always be able to adjust credit conditions in real time to respond to various economic scenarios. I find this idea reprehensible.
Modern central banking policy, and modern monetary theory, is heavily influenced by Keynesian economics, which supposes that an economy's health is tied to the level of aggregate spending. Where there is spending, there is economic activity, so the Keynesians say. Keynesian economics is about as old as the U.S. Federal Reserve, both having a genesis at the turn of the 20th century. I would argue that the Fed and Keynesian ideas both were tested early in their existence during the Great Depression, an economic event caused by, and made worse with, credit expansion. The interventions that occurred during that era likely made the recovery prolonged, and far weaker than if the economy was allowed to rebound on its own. I cannot begin to delve into that subject in depth in the brevity of this article, I would recommend reading "America's Great Depression" by Murray Rothbard. Modern monetary theory builds on Keynesian economics, but takes it a step further, allowing for endless money printing and credit expansion to keep the economy roaring in perpetuity, a truly asinine thought.
Moreover, a lesson from the Great Depression era would be that artificial interventions in the economy create artificial outcomes, making natural market mechanisms less reliable and effective when they need to be. Humans are a vain species in that we believe that twelve unelected bureaucrats in Washington, D.C. at the central bank can effectively account for the vicissitudes and endless complexities of economic activity, and efficiently control the price of capital to account for all of the aforementioned. The proposition is an absurdity, and the central bank has increasingly become the source of the problem, rather than the solution. Just think about this in the context of our current predicament, the economic fallout of the COVID-19 pandemic. We entered this pandemic with an economy firing on all cylinders, yet the central bank had begun a cycle of cutting interest rates, abandoning a tightening cycle very early, as it appeared that asset prices were collapsing due to higher rates. Of course, asset prices collapse when interest rates rise because interest rates have been artificially low for a decade, thus the sensitivity to rates is at an apex. In addition, the Fed began expanding its balance sheet through its 'repo' facility in 2019, despite the fact that the economy seemed fine on the surface. The end result is that the Fed was already using its 'tools' , which are supposed to be set aside for hard economic times, during economic boom times, thus rendering the bank less effective for our current time of distress.
In brief, the Fed has fallen victim to a fate caused by its own policies, having to be more and more reactionary as the economy does not often perform as predicted, as is evident by the simple fact that the Fed has under-performed its own inflation target for many years. The Fed is its own prisoner. This is why interest rate normalization is unlikely any time soon, or perhaps not until currencies begin collapsing. The Fed, along with the other global central banks, have turned the financial system into a funhouse mirror, fueled by quantitative easing, money printing, and artificially-low interest rates. The bankers really do not have a grasp on what the 'real' economy is doing, if there is a 'real' economy anymore. With this in mind, the Fed has pretty much taken the stance that asset prices must be propped up for as long as possible, using asset price valuations as its yardstick for whether or not the Fed's job performance is satisfactory. This is a dangerous game, one that has already been played in Japan in the 1980's and early 1990's (research Japan's 'Lost Decade'). If Japan is any analog to the present, the collective global asset bubble will continue to inflate larger and larger, until finally it pops - leading to a bear market in assets that will stretch for many decades. Hopefully, the bankers shoulder their fair share of the blame.
So what is the endgame?
I believe the era of central banking and fiat currencies is slowly coming to an end, as will be finally evident when this global asset bubble finally pops. No fiat currency has ever ultimately prevailed in human history, and we have no indication that this time will be any different than the last. The centralization of the economy through central banking will become a thing of the past, just as with other failed centralized economic policies such as communism. All of these things will be replaced by a new, decentralized monetary system that is absolutely fair, as it will be open source and immutable - built on consensus. I believe there is a very good chance such a system will be built with Bitcoin in mind, as Bitcoin's decentralized properties have made it the cure to our diseased economic times. Perhaps the system is just Bitcoin itself. Only time will tell. One must prepare accordingly.
You should always consider seeking financial advice from a licensed advisor before making decisions with your money, and you should not consider anything I write as financial advice but merely my opinion. Getting your financial house in order is a prerequisite for Bitcoin saving, in my opinion.
Disclosure: nothing in this article should be considered financial advice and I am not a financial advisor. Do your own research as everything in finance carries risk.