Ruinous effect of persistent central bank interventions

LONDON • As global markets reel after an establishment-rattling vote by Britain to sever ties with Europe, investors are again expecting central banks to ride to the rescue.

And that may be the problem.

Or so believe a number of investors and economists who worry that another round of central bank intervention in the markets will compound the sense of alienation, frustration and anger at global elites that encouraged a majority of Britons to opt for leaving the European Union.

Traditionally, market participants have tended to cheer central bank activism. In times of financial panic, wholesale bond buying, negative interest rates and disbursing cash to consumers (the yet-to-be-deployed weapon in the central banker's armoury) have been seen as easy policy substitutes for governments unwilling or unable to take action themselves.

But as the world's leading central bankers finished a weekend of brainstorming in Switzerland as to what their next move might be, some feared that this time they might do more harm than good.


People say that central bankers have not done enough, but they have done too much already.

MR STEPHEN JEN, a former official at the International Monetary Fund.

"People say that central bankers have not done enough, but they have done too much already," said former International Monetary Fund official Stephen Jen, who now manages a hedge fund in London.

Global central bankers had already planned to convene at the annual meeting of the Bank for International Settlements (BIS), a clearing house and research shop. But the British referendum results and the sharp fall in the markets that followed brought an extra urgency to the two-day meeting.

Last Saturday, Mr Agustin Carstens, the head of Mexico's central bank and chairman of the bank's policy group that monitors the global financial system, said that committee members had "endorsed the contingency measures put in place by the Bank of England and emphasised the preparedness of central banks to support the proper functioning of financial markets".

Part of the conundrum for central bankers is that the recent stock market sell-off is not the result of an event like Lehman Brothers' bankruptcy in September 2008, which provided the authorities with an unassailable excuse to intervene. Lehman's failure caused markets to seize up and financial institutions to stop dealing with each other. But when the crises that rock global finance are social and political, it becomes more awkward for central bankers to defend any form of extraordinary intervention.

And that is what worries analysts, who have been concerned that interventions by central banks were distorting markets by making them less liquid and creating anomalies such as what exists in Japan. There, the central bank owns 34 per cent of the nation's government bonds and is a top 10 shareholder in 90 per cent of the firms listed on the stock exchange, according to data from Bloomberg.

"Central banks have done everything to jury-rig markets," said Mr Julian Brigden of Macro Intelligence 2 Partners, an independent research company. "What makes you think they won't want to do more?"

Mr Jen scoffed at the notion that the extraordinary central bank interventions of recent years were designed to stamp out deflationary threats and spark a rise in prices and economic activity in stagnant economies in Europe and Japan.

"We have plenty of inflation, it's just asset price inflation," he argued, referring to elevated equity, bond and housing markets that have been one consequence of these policies. "People can't live in cities anymore, and they are grumpy about their jobs."

In Britain, this dynamic has been particularly acute. Thanks to aggressive central bank policies, house prices in London are among the most expensive in the world, yet the inflation-adjusted weekly average wage of £470 (S$860) is still £20 lower than it was before the financial crisis, according to the Resolution Foundation, a British research organisation.

Interestingly, one of the most vocal critics of central bank overreach has been the BIS itself. For years now, two of its researchers, economists Claudio Borio and Hyun Song Shin, have been arguing that artificially low interest rates have created pernicious asset bubbles in equity and housing markets in the developed world and debt frenzies in emerging markets like China and Brazil. These views were again highlighted on Sunday. BIS managing director Jaime Caruana said extremely low interest rates were a threat to global financial stability. His message was clear. Persistent central bank interventions have not only created dangerous distortions, but have also added to a sense of cynicism that these steps have not accomplished their central aims: lifting economic growth and increasing wages.

Of course, bashing central bankers is a popular and easy pastime for politicians, economists and investors alike. It is also true that central bankers in Britain, Europe, Japan and the United States have consistently said their actions have been forced by the unwillingness of politicians and governments to act themselves.

"Monetary policy cannot do it alone," said bond investor Daniel Dektar at Amundi Smith Breeden, a global asset manager. "People have been left behind, which is creating anti-establishment sentiment in just about every democracy in the world. You would think that at some point governments would get the message."


A version of this article appeared in the print edition of The Straits Times on June 28, 2016, with the headline 'Ruinous effect of persistent central bank interventions'. Print Edition | Subscribe