Fiscal year 2015 is upon us, and is fast becoming the year of historic monetary policy changes in light of an appreciating US currency and, in turn, a blanket decrease in European and Asian economic growth. Since late 2014 and in full swing 2015, the Danish central bank, the Swiss National Bank, and the Bank of Russia cut key interest rates, with probable Turkish Central Bank short term rate cuts to follow. The Bank of China has recently reduced its requirement ratio as well to encourage growth. In the US it is expected that the Federal Reserve raise short term rates by mid-year 2015, a policy change that has not been effectuated for over three years. It is apparent that governments are depending heavily on central banking to modify economic growth patterns as a short term solution.
While the spotlight is fixed firmly on central bank monetary policy to control the global economy, should central banks be fully responsible for financial stability? From a governance perspective, central banks act first and foremost as an independent or fully state-run agency to ensure adequate capital liquidity. The gist of central banking is to control the effects of growth expansion or decline, and not necessarily to be the institution to structure economic growth itself. In addition, one of the tenets of central banking is to oversee a sovereign’s commercial banking system, and be thus supported simultaneously by government legislature.
If this foundation of central banking was kept constant, we would not have had such financial turmoil in 2008. However, lack of commercial bank corporate governance due to lobbying influence has vastly undermined central banking effectiveness in the long term.
In layman’s terms:
- Short term upon short term upon short term monetary rate fixes does not equal proper long term decisions. Decisions that should be made with no biased influence from legislature.
- The global monetary system has moved from fully secured to almost totally unsecured asset-backing over the past 40 years. Most world currencies are much less asset-backed than ever before.
Both very simple reasons listed above explain why at anytime an industry receiving the most ‘creative’ cash flow (derivative upon derivative) will experience the dreaded bubble. And, while it is natural in the scheme of a global economic cycle to have peaks and troughs, the mass non-collateralization of currencies, followed by a now endemic financial culture of sophisticated derivative creation leads to unsustainable growth. It’s less long term growth and more adrenaline rush. We have more monetary policy magicians at work than real doctors of the art.
The Bank for International Settlements examined the central bank’s role in being the overseer of global financial stability in its May 2009 publication, Issues In The Governance Of Central Banks. The article points out that while central banks are needed for monetary stability, having the central bank be the main institution for overall financial stability gives unwarranted responsibility, and unnecessarily overlaps with government functions:
Governance arrangements for the financial stability function are generally less settled than for the monetary stability function…apart from the lender of last resort function and various regulatory powers, there are no central bank policy instruments that are uniquely suited to ensuring systemic financial stability. Instruments that might influence financial stability have other primary roles…Using such instruments for ends other than their primary purpose inevitably involves trade-offs.
It is therefore ill-advised policy to depend solely on the central banking model for ongoing global financial stability. Yet, from a governance perspective can individual banks be allowed full deregulation? Deregulation makes sense in a free market economy. However, judging from the shenanigans of 2008, we need checks and balances in our global banking system. In the US, bank regulation took a dive in December 2014: Section 716 of Dodd-Frank financial law, which would have forced big banks to keep their derivatives mostly separated from their insured deposits, was repealed by the U.S. Congress, with planned repeals to follow in FY2015. Can a global economy with rampant recession afford the repercussions of a huge financial crisis within the next two years? Probably not: short term policy issued by a sovereign’s central bank cannot fully override financial policy decisions made by legislature, based on corporate influence.