I have often tried to explain that the Fed, Bank of England and ECB made two grave errors over the last decade or so. Most commentators now agree that they were too lax in their requirements for cash and capital for the commercial banks in the period up to 2008. Quite a few of us said so at the time, most now say so with hindsight. Their laxity allowed or encouraged commercial banks to overexpand, lending too much. We saw property, commodity and financial asset bubbles as a result.
Most still fail to agree that from 2008 onwards the Central Banks made the reverse mistake. They demanded too much cash and capital reserve of the banks, so there was too little cash and credit available for jobs and growth. The Central Banks helped bring down a few of the large banks by their precipitate action. Since then their constant pressure for stronger bank balance sheets has meant slow growth generally.
Tim Congdon is one of the few economists to explain all this. He has done so again recently. He also points out that Quantitative Easaing, a policy he recommended, was sufficient to prevent the Great Recession the Central Banks created from becoming a Great Depression. The artificial created money did enough to offset the worst of the money destruction from their approach to commercial banks.
My view throughout has been that the authorities should not have undermined the banks in the first place, and having done so they should have acted as midwife to new stronger banks more quickly to resume normal money and credit growth. In UK terms I argued for faster and more effective measures to get RBS and HBOS lending more again as a preferable answer to QE.
Whilst I accept Tim Congdon’s argument that QE was better than doing nothing when they visited the Great recession on us, QE has had unfortunate side effects. It has created a new price bubble in bonds and other financial assets. As the Prime Minister has pointed out, it has helped the rich with financial assets more than the rest of the population.
Today we see the dangers of the price bubble in bonds. The US authorities, wedded to ultra low interest rates all the time there was a Democratic President, look as if they now want to put interest rates up. Markets have decided that Mr Trump’s reflationary policies will require higher interest rates, and have sold bonds to raise the longer term rate of interest. As a result the dollar has started to strengthen some more.
Mr Trump’s reflation will take time, as he will need to fight through the tax cuts and spending rises he wants.In the meantime the USA is experiencing a monetary tightening. Tougher language from the Fed is pushing up expectations of short rates, and unwinding some part of the bond bubble is pushing up longer rates. The world economy does not need a monetary tightening in the USA all the time so many banks around the world remain prisoners of the tougher regulatory system that has given us slow growth. Nor does Mr Trump wish to see the modest rate of growth in the USA interrupted by the wrong monetary tightening. The Central Banks can mess it up again.