Have Central Banks Lost Credibility?

The beginning of 2019 supposed to be a period of "normalization" in terms of the central banks activities. However, nothing has changed and in reality we are still dealing with the persistent currency printing which is often hidden from the citizens.

Does the currency printing influence prices?

Before we move on to the largest central banks activities, it is worth to note one important issue. Using some sort of simplification. So-called currency printing can be conducted by central bankers in two ways:

a) By purchasing financial assets

A good example of that practice can be buying sovereign bonds by the FED, corporate bonds by the ECB or purchasing stock ETFs by the Bank of Japan. This type of money creation has been performed over the last 10 years and till now had been regularly announced by the central banks. This purchase of assets has created speculative bubbles on the stock and bond markets. We have been writing about this close correlation between asset purchases of central banks and quotations of stocks and bonds many times. It is clearly shown on the chart below where the main stock market index in US is described by the red line and the total assets value owned by major central banks is showed as the blue line.

Looking deeper into it we can conclude that the purchase of financial assets means that new funds appear on the financial markets. The net effect is the inflation of stocks and bonds prices. However, the currency does not flow to the real economy and does not influence prices of goods and services. In addition, the purchase of assets helps growth of the small part of the people in the general wealth of the society - the richest. This is confirmed by the graph below:

The blue color indicates the share of 0.1% of the richest Americans in the US household wealth. For comparison, the red color determines the share of 90% of the poorest people. What is the relationship with the stock exchanges? It is significant. Since the prices of shares and bonds were pumped up, and real wages not risen, the richest part of the society has benefited the most from it. To be clear, poor people usually do not own securities.

b) By increasing the availability of credit

It can happen in various ways. First, through the reduction of interest rates, which have been done by central banks during the recent financial crisis, initiating the era of "zero rates". However, there are also other ways, such as special loans with low-interest rates for companies (example of the ECB actions) or decreasing the level of reserves that commercial banks have to maintain (example of the Bank of China actions).

As a result of these activities, the currency actually flows to the real economy. For instance, a particular citizen gets a loan, buys a house, furniture and goes on vacation. The currency is circulating. Similarly, the company takes a loan and spends it on investments, while increasing employment. Therefore, in this case, the appearance of the new currency in the economy ultimately contributes to the price inflation of goods and services.

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Moon Kil Woong 8 months ago Contributor's comment

Sadly Japan is in a QE hole they can pretty much never get out of without a serious collapse in their economy. Their economy is dependent on the funny liquidity and their markets are increasingly driven by it and the government. This is why their economy doesn't ever recover. Their people's future is not in their own hands thus it is hard for businesses to bet on what they can't control. Thus understandable no one wants to invest in growth.