Central banks as part of the banking community

What I would like you to do with me today, is to try out a different angle for looking at the ECB and at central banks in general. I will not promise you that you will get the complete picture from this angle, but you might see stuff you have not seen from the usual angles.

From the most common point of view, the ECB looks like a special government entity which wants to promote the interest of the population at large, and does so more or less imperfectly, depending on your attitude. Perspectives differ a bit of course between conservatives and the left. The left would usually accept more inflation to get higher wages and more employment, the right would tend to argue that the general good is served best if inflation is kept low. While disagreement can be fierce, the general angle from which both sides look at the ECB  is more or less the same and the ECB’s motivation and nature is not questioned.

This is a major mistake.

A lot of what the ECB does and refuses to do, can be much better understood by thinking of the ECB as an integral part of the banking community, as an institution, which will always side with the banks, whenever  the interest of banks should not coincide with the interest of the general public.

This is not at all a far-fetched idea. Historically, central banks were set up as commercial banks. The Bank of England was a commercial bank well into the 20th century.

The Bank of North America, the first predecessor of the Federal Reserve,  was created and run by Robert Morris, a banker, for his own profit. He also served as superintendent of finance.

The First Bank of the United States, the next attempt at a central bank, was also a private business and so was the Second Bank of the United States. There was a lot of argument about this fact at the time, and both quasi-central banks lost their charters, because they were accused of furthering bankers’ interests instead of the interest of the general public.

Finally, the plan for setting up the current US Central Bank, the the Federal Reserve System was created at a secret meeting of the most influential international bankers of the time. It was pushed through a reluctant congress at Christmas of 1913 when few paid attention.

The governance of this central bank was intentionally set up in such a way, that government would have very little control and bankers very much.

Over the decades, as these banker controlled central banks failed miserably. Governments asserted more and more control.

However, economists invented a theory of time inconsistency to pry away central banks from any control of the government again and in effect give control back to the banks. They argued for and got the same independence from government as the bankers had originally secured then the Fed was created. But note that at the time the Fed was created, stabilizing inflation was not even a target of the Fed and thus time inconsistency was not an issue.

The fact that commercial banks’ control the Federal reserve can best be seen in the US where all the regional Federal Reserves are owned and controlled by the commercial banks of the respective area, including the mighty New York Fed, which is in charge of supervising Wall Street.

Things are not so much different in Europe. During the financial crisis, commercial banks in Italy had a problem with a lack of capital. What did they do. The nominal capital of the Bank of Italy was written up by some billions. This resulted in a large capital increase for the big banks, which own the capital of the Bank of Italy. The Bank of Italy has a very large hoard of gold. Now it is clear, who this gold belongs to. It does not belong to the Italian people. It belongs to the financial institutions which own the Bank of Italy.

Let’s stop here with the historical and institutional detail and look at the words and deeds of our central banks.

First to the words. All central bankers agree, according to Jens Weidmann, that capital markets have to be in charge of supervising governments’ fiscal policy. In this, they are in total agreement with people like Rolf Breuer, former CEO of Deutsche Bank, who wrote a long article about the virtues of having governments supervised by the fifth power. “The 5. Power” is another word for financial markets which is another expression for “large international financial institutions”.

The ECB and other central banks do not only talk about the control of financial institutions over governments, they enforce it vigorously. They have even brainwashed the German constitutional court, which held that it would be unconstitutional, if governments would be relieved from the pressure of financial markets.

The ECB is not even hiding its very warm and protective feelings for commercial banks. It wears them as a badge of honor, saying that everything which is good for banks is good for the economy and thus for all the people.

The economy and governments, thanks to a system controlled by the ECB, are so dependent of healthy banks, that this is true. Thus, it even makes sense, bizarrely, that a declared priority of the banking supervisory arm of the ECB for this year is to check profitability of supervised banks. Large banks, supervised by the ECB, will have the treat of having a very powerful institution working on ways to increase profits with them. Too-big-to fail will not go away like that.

By the way, that the ECB’s supervisors look after the profitability of bankd is a suggestion from the Group of Thirty. This is a conspiratorial group of high level commercial bankers and central bankers, including Mario Draghi, which meets behind closed door.

There is much more to say, but time is short. Let’s go to the main deeds.

The ECB’s quantitative easing programme has been ineffective in delivering its purported primary objectives of producing higher spending, higher inflation and a return to economic growth.

This is because it relies on the banking sector and financial markets.

In their own verbiage central banks focus on incentivizing banks to lend more, but this is only a minor effect of QE. In the countries where more lending is needed, banks are week and want to repair their balance sheets and credit risk is relatively high. Thus, not much extra lending is happening.

The easier way for banks to make use of extra ECB money is to buy stuff. Banks can buy stocks and bonds and real estate, driving up the prices of such assets. Some admit that this is a major channel they have in mind (Bank of England, Greenspan), with others it is clear from their actions. They pay close attention to the stock market and get very nervous if it tanks

The Federal Reserve has been giving signals for years that in about nine or twelve months’ time they would raise rates. But then, some stock market weakness would always occur and they would reverse course.

The ECB signaled last autumn, that they would intensify their QE-programme and maybe lower rates more, which they eventually did. There were basically no bad news from the economic side. But stock markets had tanked badly over the summer.

If the ECB is seen as an institution which has the purpose to protect and help enrich the financial sector and the rich, the ECB had done a stellar job, at least until the end of last year. The assets whose prices are driven up by such financial market oriented policies are disproportionally owned by the rich and by the financial sector. In the US, the top 0.1 percent now own as much of them as the bottom half of the population. In Europa it is not quite as bad, but similar.

To be sure, some advantages from booming asset markets, or from asset markets that are prevented from imploding trickle down to ordinary people earning their living in  the real economy, but this is only a second order effect. First and foremost it makes bankers and other rich people even richer.

Between the post-Lehman low and the end of 2015, stock markets in the US and Germany have almost tripled, in the Euro area almost doubled. In the US and Germany they have been – at the end of 2015 – significantly higher than the pre-Lehman record highs, in the Euro area, they came close. Financial institutions and rich people who own these and other central-bank-inflated assets do not have any reason to complain.

As an aside: The term trickle-down was first used by an American comedian Will Rogers, mocking the misguided depression-era policies of Herbert Hoover. He said: “the money was all allocated to the top, in the hopes it would trickle down to the needy.”A few decades later, economists made this a dogma and were not even ashamed to call it trickle-down economics.

What are the alternatives? What does the ECB not do, because it is not in the interest of the banking community.

They would not countenance  “QE for People” or “monetary financing” that would direct new money into the real economy rather than into asset markets. They would not do this, even though, such alternative monetary policy mechanisms can be expected to be many times more effective than QE in boosting demand and output.

There are several options for how monetary financing could boost demand in the real economy. Two examples are: The ECB could transfer newly created money to national governments. These governments would then use the newly created funds to increase their spending. Alternatively, the newly created money could be distributed equally between every citizen of the Eurozone. This type of “citizen’s dividend” would put additional purchasing power directly into people’s pockets.

There is just no way, that either of these measures would not boost demand. And this would be achieved without anybody going deeper into debt, as the current policy requires to be effective. And it is very easy to finetune. Send out a check of 500 Euro to every citizen. If it is not enough, send another one. Until it is enough to get the economy going.

Otmar, Issing, the former ECB Chief Economist, who went directly into a highly paid lobbying- job at Goldman Sachs after his departure from the ECB, said correctly that this would be a disastrous option for the commercial banks and the ECB. Citizens or governments would want to continue this mechanism even in non-crisis times. This would mean, that no money would be left over to be given to the banks as a gift.

You do not even have to rely on my word regarding the effects of QE. You can rely on the word of central bankers and of the super rich, who should know.

Andew Huszar of the Fed apologized in the Wall Street Journal:

“I can only say: I'm sorry, America. As a former Federal Reserve official, I was responsible for executing the Fed's quantitative easing. The central bank continues to spin QE as a tool for helping Main Street. But I've come to recognize the program for what it really is: the greatest backdoor Wall Street bailout of all time. Trading for the first round of QE ended on March 31, 2010. The banks enjoyed huge capital gains on the rising values of their securities holdings and fat commissions from brokering most of the Fed’s QE transactions. Wall Street had experienced its most profitable year ever in 2009, and 2010 was starting off in much the same way.”

Donald Trump said [2]:in 2012 on CNBC on Quantitative Easing:

“People like me will benefit from this.”

In August 2012 the Bank of England admitted in a report that its quantitative easing had benefited mainly the wealthy. It said that its QE program had boosted the value of stocks and bonds by 26 percent, or about $970 billion and that about 40 percent of those gains went to the richest 5 percent of British households. (…)The BOE countered critics by stressing  that the benefits of easing may have trickled down, and that “without the Bank's asset purchases, most people in the U.K. would have been worse off."

Billionaire hedge fund manager Stanley Druckenmiller said [3] the on the occasion of a Federal Reserve’s  decision to delay tightening of its monetary policy:

“This is fantastic for every rich person. This is the biggest redistribution of wealth from the middle class and the poor to the rich ever.Who owns assets—the rich, the billionaires. You think Warren Buffett hates this stuff? You think I hate this stuff? I had a very good day yesterday.”

Thank you exploring this alternative perspective with me.