If We Just Keep Tinkering, Something May Eventually Work …
Bloomberg has published an interesting article that will either make you laugh out loud or make you tear out your hair with frustration. It is entitled "Ikea Economics Lure Central Bankers Seeking New Tools".
The reference to Ikea is explained in the introductory paragraph:
"If you've ever bought a folding futon bed from Ikea you'll probably have been both impressed and perplexed by Scandinavian ingenuity. It's the same when it comes to central banking. Policy makers are looking to Sweden,Norway and Denmark for off-the-shelf measures they can build at home."
These 'off-the-shelf' Scandinavian measures consist mainly of the imposition of negative interest rates, which have been 'tried out' in Denmark and Sweden. Why the practices of these countries should serve as an example worth emulating is a bit mysterious, considering that they are home to some of the most egregious real estate bubbles and concomitant household credit bubbles the world has ever seen (we have previously discussed the situation in Denmark, Sweden and Norway in some detail).
The article continues:
"Sweden invented the central bank, establishing the Riksbank in 1668 after the public lost confidence in the paper money produced by Stockholms Banco. Bank-rescue strategies in the 1990s and efforts to improve central-bank communications through forward guidance taught lessons to first responders in the recent global financial crisis. Now, the European Central Bank is considering copying Sweden and Denmark by charging banks to hold their money. And the Bank of England may mimic steps taken by Sweden and Norway to tame a housing boom."
The Bank of Stockholm (which was the forerunner of the Riksbank) was founded in 1656, and initially adhered to a 100 percent reserve in its deposit banking operation (the bank had two separate divisions for deposit and loan banking). However, it soon began with the practice of issuing bank notes well in excess of its reserves. As a result of the bank engaging in fraudulent fractional reserve banking, its depositors were left with worthless slips of paper. It took only 12 years from the bank's founding to its bankruptcy. After it had been nationalized by the government in 1668, the fraud was simply continued under a new name and under the direction of the government.
Banknote issued by the Bank of Stockholm, which was theoretically redeemable in silver. Unfortunately for depositors, they found out that the silver wasn't there anymore when they tried to redeem their notes.
The idea to 'mimic' the modern-day heirs to this operation drew critical remarks from a SocGen analyst, although Bloomberg doesn't mention what the critique actually consisted of, except for noting that the policies are held to 'carry risks':
"They've drawn warnings from Michala Marcussen of Societe Generale SA that negative deposit rates and mortgage-focused regulations carry risks: "Central banks, learn from thy neighbor!" she said in a report this week. Sweden cut its deposit rate to minus 0.25 percent in July 2009 and held it there until September 2010. Denmark followed in July 2012 until last month as it successfully prevented an appreciation in the krone from capital inflows. Draghi is poised to go Scandinavian next month when most economists expect him to make the ECB's deposit rate negative, in effect turning it from a payment to a fee. The idea is that banks would respond by seeking returns elsewhere through loans to companies and consumers. A decline in the euro would also be a welcome byproduct to exporters such as Airbus Group NV."
As we have already pointed out, this makes no sense regardless from which angle it is considered. There is no 'credit crunch' that can be alleviated by imposing the penalty rate, as there is only a ridiculous 1% required reserve ratio in the euro area anyway, the banks are able to refinance themselves at the ECB by offering all sorts of toxic crap for discount, and moreover already hold reserves far in excess of the reserve requirement. They are not earning a dime on their excess reserves (the interest rate is already at zero), so if the object is to 'force' them to seek higher returns, they already have all the incentives they need. The fact is that there is A) little credit demand and B) if the over-leveraged European banks were to expand their inflationary lending even more, they would run the grave risk of ending up with even more non-performing assets on their books.
Credit is not only a question of creating new money from thin air. Ultimately a limit is imposed by the real capital available. As to weakening the currency to 'help Airbus' or other exporters, not only are the 'advantages' strictly temporary, but the sector that is temporarily supported is only a small part of the economy.
In his last ECB press conference, Mario Draghi announced that fresh central bank tinkering was to be expected in June. It is widely expected that he will resort to the imposing a penalty rate on bank reserves, similar to Denmark and Sweden.
Macro-Prudential Arm Waving
Bloomberg then cites another analyst who also warns of the likely unintended consequences of 'Ikea economics'. As Nordea Bank's chief economist points out, the effect of imposing negative deposit rates in Denmark was the exact opposite of what the ECB apparently expects it to be. All that happened in Denmark was that the banks passed on their additional costs to consumers, but lending didn't increase:
"Denmark's experience suggests reason for caution, according to Helge J. Pedersen, chief economist at Nordea Bank AB in Copenhagen. That's because a negative deposit rate threatened bank profits, forcing them to pass the cost on to consumers. The result was that lending remained stymied. "It's risky to do it," said Pedersen."
Or putting it differently: the economy is not a 'machine' as some have argued. Pulling this or that lever in order to force people to do what they plainly don't want to do either makes them find ways around the new obstacles so as to continue doing what they wanted to do in the first place (which in this case is: not expand borrowing and lending any further), or it will 'succeed' by inducing them to misdirect scarce capital, which can hardly be termed a desirable outcome.
Another idea that has become extremely popular in the wake of the 2008 credit bubble crash is so-called 'macro-prudential' supervision of bubble activities. The assumption is that the destructive effects of the central banks' monetary pumping and interest rate manipulation can somehow be mitigated by creating regulatory obstacles to those bubble activities the regulators somehow manage to spot. Considering their absolutely dismal record in actually identifying such activities, an enormous leap in faith is required ab initio already. Moreover, for a number of reasons, even the most well-intentioned interventions are doomed to fail anyway.
"As for Carney, he's also looking toward Scandinavia by warning rising housing prices pose the biggest risk to his economy. That may force him to introduce rules to curb mortgage lending. Trouble is, restraints haven't much tamed animal spirits from Stockholm to Oslo. Swedish consumer debt of homeowners has ballooned to 370 percent and apartment prices, which have almost tripled since early last decade, rose at an annual rate of 8 percent in April. In Norway, the housing market is rebounding rapidly, reversing a 6 percent drop in the last seven months of 2013. Similar measures in the U.K. also could fall flat, yet still force up the pound and gilt yields, imposing deflationary pressure similar to the Sweden, says Marcussen, who suggests governments may need to take fiscal steps or build more houses. The advice: assemble with care."
In other words, not even the specific sectors such regulations were aimed at have reacted in the desired manner. Even if it were possible to e.g. stop the formation of a housing bubble by imposing specific regulations, this would still leave the pumped up money supply in the economy looking for a home (no pun intended).
Bubble activities would simply shift to other sectors in the economy which the central bank is not paying attention to. The only solution is to refrain from money printing in the first place. In fact, the advice given at the end of the Bloomberg missive ('assemble with care') should be replaced with the advice to simply give up on central planning altogether. The idea that any socially useful economic outcomes can be achieved by coercion (whether it is by traditional central bank policies or any other 'tools' they bring to bear) is erroneous in principle already. People can indeed be fooled into making unwise decisions in terms of lending, borrowing and investing, but it should be obvious that this can never achieve the officially stated aims.