From Reckless Bankers to Reckless Central Bankers?

08/06/2015 16:56 BST | Updated 05/06/2016 10:59 BST

Almost every day I read someone, usually on the left, bemoaning the excesses of "neo-liberalism". They have good cause. Although there are many problems to which the best solution may well be a market-based one, the idea that this applies to every problem, everywhere and at all times is sheer dogma. Apart from anything else, it is obvious that the scope of human actions is not in fact limited to market ones but also includes the hierarchies of state and government, and the much neglected sphere of community cooperation and collective self-help, not to mention family, kinship and clan. The doctrinaire insistence that markets hold all the answers is especially misleading when asymmetries between capital and labour already pervade the system. As the heterodox economist Steve Keen points out, when capital is deregulated but labour regulated, the result is not a level playing field.

But the assertion that market forces should rule everything is even stranger when one considers that ever since the financial crisis of 2007-8, there has been massive official intervention in markets in the form of interest rate manipulation, currency depreciation, bank bail-outs and "quantitative easing" (QE). In the latter case central bank reserves are created out of nothing and then used to buy government and corporate bonds, and sometimes equities, out of the market. These market interventions have been prodigious. Since 2008 the Bank of England has bought gilts and corporate bonds to the tune of at least £375 billion. The Federal Reserve has expanded its balance sheet by almost $4 trillion. In March 2015 the European Central Bank started buying European government bonds at the rate of €60 billion per month and has vowed to continue this until at least September 2016. (These figures may be out-of-date or estimates but the point is still clear).

So when it comes to economic intervention it seems there is one rule for the rich and quite another for the rest - for the beneficiaries of the current policy are primarily a banking and financial elite who are able to borrow money at near zero interest and buy higher yielding assets that also promise a capital gain. This money is supposed to stimulate economic growth through "trickle down" and be used to invest in productive activities. But in reality central banks have no direct control of the money supply. They need commercial banks to take central bank money (which only circulates in the banking system) and, on the back of it, lend newly created credit money into the economy. But financial institutions are much more interested in speculation (and the bonuses it generates) than in the relatively low rate of return accruing from productive investment in the real economy. Hence the post-crisis boom in financial assets (stocks and bonds are at or near record high values), widening inequality but a sluggish and fitful recovery of the real economy.

We are often told that QE is an "unconventional" and "unprecedented" step. But in reality there have been many occasions when central banks have moved from being impartial referees to being speculative market participants. Almost three hundred years ago in France John Law's Banque Royale was busily printing money that was pumped into the Mississippi Company's stock - a scheme that was supposed to eliminate the French national debt but actually ended in a very damaging collapse. In England at the same time the South Sea Company was "bubbling a nation", although here the instrument was credit creation by a private bank highly networked into the governing elite. More recently we have had the dotcom bubble and the housing bubble. Historian Niall Ferguson identifies three structural features of such bubbles: a group of insiders who know much more than others about the real conditions of trade; overseas speculators distant from mania psychology and who can profitably time their sales and purchases; and a central bank (or similar quasi-governmental agency) able to create credit and/or money to inflate the bubble. In this respect it is interesting to note that modern central banks conduct their bond purchase operations through a small, near monopoly group of "primary dealers" (an insider group who can and do front-run the market), bond market players are global and often disengaged from domestic economic concerns and (as argued above) currently central banks have gone beyond merely allowing the inordinate expansion of credit but have become direct speculators in the market.

If, as appears to be the case, the bond market is in a bubble then it is anybody's guess how long it can last or how it will end (although history suggests it will not conclude well). Bond yields (which move inversely to bond prices) have already reached levels once thought impossibly low, even on occasion becoming negative - so that bond holders actually pay to own the bonds rather than getting a return on them. The spread between high risk and low risk bonds has declined to an absurdly small level - although it has, ominously perhaps, recently started to steepen. On top of this, even high grade bond prices have become much more volatile than normal, with large proportional short-term swings in price. But, I hear you say, our central banks are staffed by smart people with much more knowledge than in the days of John Law or the South Sea Company. They have PhDs, powerful computers and sophisticated mathematical models. They know what they are doing. Don't they? Surely?