Never mind the politicians, worry about the central bankers
I know there was an election this week, and that a lot of people are complaining about mediocre politicians and sound bite policies. But there’s another (unelected) group of people that you should be just as worried about: central bankers.
Never mind politics. If you want better monetary policy, you should force central banks to follow three rules:
1. Do no harm;
2. Always ask: “What have we done before that works a lot?”
3. Then ask: “Who can tell us if our policies are good for banks?” And listen.
It won’t happen, though. Bank-bashing economists and lawyers run most central banks today. They can’t fathom that usually when banks win, society wins. Today’s anti-bank zeitgeist scoffs at that, but it’s true.
The Federal Reserve epitomises this. Years ago, Fed members had bank experience and a natural affinity for banks’ success. They knew that bank profits and societal prosperity ran in parallel. Bank earnings recirculate via dividends, share buybacks and loans, so money magically multiplies across Main Street. The more banks can profit from each new loan, the more they’ll lend — financing consumer spending, business investment and more. Lending makes economies go. Bank-experienced Fed members knew that. They weren’t perfect, but they were good enough.
If central banks always weighed how policy impacted banks, they’d act smarter. The ECB wouldn’t bleed banks with negative deposit rates. The Fed wouldn’t keep the deposit rate (at which banks borrow from the Fed) half a percentage point above Fed funds rate (at which banks borrow from each other), effectively penalising them for pumping liquidity.
Long ago, the Fed knew that dropping discount rates below fed fund rates was quick, easy stimulus because banks could profit by borrowing from the Fed and lending to each other.
Central bankers today don’t grasp this, because they aren’t bankers. Lawyers and economists run the Fed. Chair Janet Yellen has boomeranged between academia and the Fed since the late 1960s. She has never worked at a bank. Vice chair Stanley Fischer was a professor and IMF bigwig. He spent three years as Citigroup’s vice-chairman in the last decade but worked on regulation, not banking.
Lael Brainard was a professor, think-tanker and political adviser. Daniel Tarullo was a lawyer, regulator and presidential cabinet member. Only Jerome Powell has non-executive banking experience, way back in the 1980s and in investment banking, not deposits and loans.
Fed leaders know laws, models and politics, but not reality. They view big bank profits and salaries as evidence Wall Street is leeching Main Street– Ken Fisher
Fed leaders know laws, models and politics, but not reality. They view big bank profits and salaries as evidence Wall Street is leeching Main Street. They don’t believe a bustling banking system builds basic growth. They should really want bankers and shareholders to earn more. When banks build net income, they build economies.
Since Fed leaders don’t understand banks, they also don’t know how monetary policy used to work. Decades back, Fed members knew that the yield curve spread makes banks go. Banks borrow at short-term rates and lend at long-term rates — the spread, the “net interest margin”, is their profit. Wide spreads stimulate lending, money supply and growth. Slim spreads slow lending and inverted spreads choke it. When making monetary policy, the Fed wouldn’t view short rates in a vacuum. They’d view the spread, manipulating it to boost or tame credit.
Yellen’s Fed forgets the spread. It wrongheadedly fears hiking rates “too soon”. It didn’t fear when long-term bond purchases (quantitative easing) flattened the yield curve, choking lending until quantitative easing wound down last year. They didn’t fear keeping the discount rate above Fed funds, which has tightened credit nonstop since 2008. Yet now they fear. If they considered the yield curve spread, presently around 190 basis points, they wouldn’t.
The lack of institutional memory astounds me. Of today’s rate-setting committee, only Ms Yellen and Jeffrey Lacker were there in June 2004, when the Fed last started tightening. Then, Alan Greenspan’s Fed raised rates 17 straight times, inverting the yield curve in June 2006. A lesson in what not to do.
It’s not just the Fed. Central bankers worldwide are woefully short on banking experience. The UK’s nine-member Monetary Policy Committee has only four members with any banking experience, and even then, only as investment bankers or staff economists. Of the 25-member European Central Bank governing council, only five have worked at a bank, and again, mostly as staff economists. The Fed may get one soon, as Congress now requires one board member to have community banking experience. But that’s only a subset of full-scale commercial banking. It should have a lot of banking experience. Until then, they can’t follow rules 1, 2 and 3.
But if then, a banker could remind other policy makers that the yield curve matters most and an initial hike won’t invert it. No initial interest rate rise since 1970 has inverted the yield curve or caused a bear market. While they work all this out, breathe easy and own stocks: world stocks have averaged 10.8 per cent the first year after each such an initial rate rise, positive seven of nine times.