With just a few words ECB President Mario Draghi ushered in a new era of central bank dependency. Investors should be mindful of the high expectations for this experiment in monetary policy.
Lest there was any doubt, European Central Bank President Mario Draghi spoke on behalf of central bankers worldwide in pledging to do “whatever it takes” in the latest fight against the stubborn complications of global indebtedness. Draghi’s July 26th comments were directed specifically to his commitment to preserving the battered Euro but his three words adequately summarized the sentiment of his long-winded cohorts.
Shortly thereafter, Australia lowered its benchmark interest rate, Japan announced it will buy more bonds and extend long-term loans to its banks and China injected billions into their economy. It took a few weeks, but Mario Draghi even offered some clarity in explaining that “whatever it takes” will include unlimited buying of short-term sovereign debt in an effort to keep borrowing costs low for the cash-strapped countries in his fragile European Union.
Not to be outdone, our Fed President Ben Bernanke trumped other central bankers and lofty market expectations alike in announcing another round of money creation and subsequent U.S. government bond purchases. Unlike previous doses of QE1 and QE2 though, this third round lacks a quantifiable limit. Metaphorically 40 billion in new dollars will roll out of the printing press every month until the cows come home – or until there is “substantial improvement in the outlook for the labor market,”¹ whichever comes first. And just in case unemployment abates sooner than expected, electronically creating money to buy debt evidently “remains appropriate for a considerable time” even “after (the) economic recovery strengthens.”² ‘Twas music to a gold bug’s ears.
Stocks, bonds and other commodities followed the yellow metal higher on the announcement as investors expected central bank policies will either keep asset prices elevated or eventually manufacture the economic growth needed to justify higher valuations.
Readers are familiar with this author’s skepticism for the latter but may find Philadelphia Federal Reserve governor Charles Plosser’s comment’s intriguing. “In my view we are unlikely to see much benefit to growth or to employment from further asset purchases,”³ he said, clearly breaking rank with Chairman Bernanke. Plosser’s position appears justified as two well-publicized rounds of quantitative easing and a crafty maneuver to lower mortgage rates have offered only tepid economic growth thus far. This time though the Fed will repeat the process until a different result emerges. No apology has been offered in the event this sounds eerily familiar to the often-quoted definition of insanity.
The policy of printing money is usually defended in light of the increasingly short list of alternatives. Academics may debate whether such justification is defensible but investors are more interested in the reality that Draghi and Bernanke have ushered in a new era of central bank dependency.
With legislatures hamstrung by political differences and a dearth of credit, central banks have assumed the responsibility for managing the numerous complications of personal and government deficit spending. The growing list of responsibilities includes containing low interest rates, repairing the housing market, creating jobs and generating meaningful economic growth.
The responsibility seems to be a particularly tall order. However, investors have been repeatedly assured that the challenge will not be conceded. There is no doubt that central bankers will attack the lingering crisis with every tool at their disposal. Still, investors are left to determine whether central bankers will ultimately be successful in generating economic growth or simply impress markets with their creative efforts to postpone the pain of economic contraction.
Clearly the stakes have been raised as the inability of central banks to deliver sustainable growth threatens not only a fragile global economy but, more importantly, investor confidence in the individuals and institutions shouldering the responsibility for an economic recovery.
In case investors are growing uneasy of this experimental debt shifting and currency creation, perhaps they can take solace in Mario Draghi’s personal guarantee to the now famous “whatever it takes” pledge. “And, believe me,” he said. “It will be enough.”
Time will tell.
1 Yellen, Janet, “Revolution and Evolution in Central Bank Communications” – Board of Governors of the Federal Reserve System. Web 13 November 2012. http://www.federalreserve.gov/newsevents/speech/yellen20121113a.htm
2 Federal Reserve Open Market Committee, “Press Release” – Board of Governors of the Federal Reserve System. Web 24 October 2012. http://www.federalreserve.gov/newsevents/press/monetary/20121024a.htm
3 Plosser, Charles, “Economic Outlook and Monetary Policy” – Federal Reserve Bank of Philadelphia. Web 25 September 2012. http://www.philadelphiafed.org/publications/speeches/plosser/2012/09-25-12_cfa-society-of-philadelphia.cfm
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