On Central Banks

For most of us, the central bank is much like the sun – we know it’s there and understand that it mostly does us good, but otherwise know little about it. Now if some alien power came along and began tinkering with our sun, changing the amount or quality of radiation it produces, we’d all be freaking out.

In the same way, everyone on the planet needs to get concerned when the government of the country with the largest and most influential central bank in the world (by far) wants to start amateur tinkering with it. What’s going on is the financial equivalent of replacing all your 15 amp circuit breakers with 100 amp breakers so they’ll stop annoying you. Works fine until your house burns down.

Alarmist? Well, this experiment has already been tried in Argentina, Turkey, and in the 1920s in Germany. Didn’t work for them, but maybe better luck this time.

In simplest terms, the role of a central bank is to keep its country’s money as healthy as possible, that is, to ensure money maintains its best possible purchasing power. This means that your dollar will buy at least as much next year as it will this year. Otherwise, better to spend all your money today rather than have it fetch half as much tomorrow.

One of the key ways to control the value of money is to raise or lower the price you charge to use it, that is, adjust interest rates. This is managed in a variety of ways, but mostly by setting the rate the central bank charges your bank and mine for “overnight money”, one of the chokepoints in the system. This gets a little complicated, but think of it as opening or closing the throttle in a carburettor to regulate the speed of the car.

Now, the experts who run central banks are economists. Populist politicians like to paint economists as a bunch of pointy-headed cloud dwelling dweebs, lost in a non-real world and out of touch absolutely with “real people”. This is utter bullshit, serving only to make us look away while they put a rabbit in the hat.

Those economists in the employ of your investment management company, for example, need to read tea leaves extremely well or your portfolio will zig when it should have zagged. You and a million other investors wouldn’t like that much, would you? Economists are probably as “real world” as you get.

Economists are the academic equivalent of Formula 500 engineers and mechanics who are light years ahead of you and me and the boys with a case of beer tinkering under the hood of a ‘57 Chevy. And like top litigators, the finest surgeons, and fighter pilots, what economists do is a subtle blend of academic knowledge and instinct, fine-tuned in years of hands-on doing. You and I could no more second guess the head of a central bank than we could take over the controls of an F-35.

But the genius behind Trump Steaks, Trump Airlines, Trump University, and Trump Casinos feels quite competent to slip casually behind the wheel of the Federal Reserve. Better buckle up, folks, it’s gonna be quite a ride, because there’s even more.

In the case of the American central bank, known as the Federal Reserve, keeping control in the hands of experts, as has been the case since roughly the end of the Great Depression, is important not just for America, but for the planet. This is because America’s economy, at least so far, is bigger than almost all the others put together, so the American money supply is bigger than almost all the others put together, which means that it is the effective currency for international trade, a great stabilizing effect.

More important for America, though, is that because America effectively controls the world’s currency system, it gets to cut itself a really sweet deal when borrowing money. It’s kind of like owning the bank where you get your mortgage. (Effectively, this means that the rest of the world is lending money to America at bargain rates, the same “trade deficit” that Trump keeps moaning about.)

This in effect allows the American economy to run a lot cheaper than would otherwise be the case. Think the government’s borrowing costs are out of control now? Just wait until Amateur Hour is done, and the system is broken, with rates double or triple what they are currently. There’s no magic wand to fix that.

Now, a government whose leading lights are talk show hosts, football coaches, a lawyer masquerading as a doctor, and a president whose only business success occurred on “reality” TV, are second-guessing the biggest and most critically important central bank in the world. If one, even one, of them were an accomplished economist (even what’s-his-name) I’d be less terrified, but what we face is like having a speeding car full of monkeys given free access to the brake pedal and accelerator.

So, the question becomes, what happens to the entire planet when and if Trump and his cast of whiz kids start tinkering with the Formula 500 engine which is the Federal Reserve? What indeed could go wrong when you run the thing past the redline?

Yee Haw, buckle up! We’re about to find out!