Are Central Banks Losing Control?

Eight years after the crisis of 2008-09, central banks are still injecting $200 billion a month into the global financial system to keep it from imploding.

If you want a central banker to choke on his croissant, read him this quote from socio-historian Immanuel Wallerstein: "Countries (have lost the ability) to control what happens to them in the ongoing life of the modern world-system."

Stated another way, Wallerstein is asking: what do central banks no longer control?

The quote is from Wallerstein's recent meditation on China: China is Confident: How Realistic?

"The question is how realistic is this self-assessment of China? There are two premises embedded in China’s self-confidence, whose validity need to be investigated. The first is that countries, or rather the governments of states, can actually control what is happening to them in the world-economy. The second is that countries can effectively contain popular discontent, whether by suppression or by limited concessions to demands.

If this was ever even partially true in the modern world-system, these assertions have become very dubious in the structural crisis of the world capitalist system in which we find ourselves today."

Central banks still claim absolute control over their currency, interest rates,what's legal/outlawed in their financial systems, and so on.

The article is ludicrously wrong in its reasoning and conclusions. No wonder: the article is by Charles Hugh Smith, an Internet commenter and finance writer of the doom-is-near-buy-gold type, whose only credential is a college degree in philosophy from the University of Hawaii. Smith's article in turn relies on an analysis by Immanuel Wallerstein, an academic sociologist given to neo-Marxist critiques capped by predictions of catastrophic worldwide doom for capitalism.

Unless made by qualified experts or closely reasoned and well-grounded on fact, dire warnings about subjects that deeply involve specialized knowledge and expertise should be heavily discounted or rejected outright. Somehow though, even as we would laugh at ever letting sociologists or humanities professors design and build moon rockets, we often seem to indulge their economic theories and warnings when they are pumped up with the right kind of gasbaggery and some isolated facts.

To address the article’s opening claim, there is no question but that in today's world financial system, major central banks are no longer central in the way they were in the era of mostly self-contained national economies. Instead, due to the immense volume and importance of trade, international investment, and currency trading, the world's major national economies and central bankers are meshed with the international economy, to the dollar as the world's trade and reserve currency, and to the economies and currencies of their major trading partners.

This does not mean that central banks have lost the control necessary to their role. Of necessity -- and mostly beyond public understanding -- the leaders of the world's major economies and their treasuries and central banks coordinate their economic policies, data, and currency management through mechanisms like the G-8, the OECD, the BIS bank (Bank for International Settlements), and other institutions.

In effect, with the US Fed at the apex, this collaboration is how the world now carries out central bank functions. And due to America's size and strength and the dollar's key role, the US Fed is the closest thing that the world has to a central bank. As the 2008 financial crisis illustrated, the Fed and the US government are the world's de facto lender of last resort and backstopped the world economy by providing the emergency liquidity and guarantees necessary to prevent a financial collapse.

Contrary to Smith and Wallerstein, the massive creation of currency liquidity by Fed and the major central banks of the industrial democracies is not some haphazard or reckless thing but is due to coordinated and deliberate policy choices endorsed by their political masters and based on the best expert counsel. The Fed and other central banks can still get things wrong, of course, but they are far more likely to be right than an academic sociologist and a college graduate in philosophy opining on the Internet.

The puzzle for gold bugs and hard money monetarists is that, for almost a decade, the major industrial economies and the world economy have absorbed these massive doses of liquidity without a corresponding burst of inflation. How can this be? The 2008 crisis and the ensuing recession caused both a fall in the velocity of money and a caution driven increase in business and consumer demand for cash and cash equivalents. This helped to tamp down inflationary pressures despite increases in the money supply.

In addition, the development of China and other emerging industrial economies led to increases in the supply of both manufactures and raw materials that suppressed inflationary pressures. Meanwhile, those countries absorbed new dollar liquidity and put it to work in their economic expansions. Thus part of the flood of dollars created by the US Fed helped power economic growth throughout the world, lifting many hundreds of millions of people out of dire poverty. Does this sound like a crisis of capitalism? Or that the world economy is on the brink of runaway inflation?

To be sure, the US and the world’s other mature industrial economies have a set of problems that risk economic stagnation and decline -- alarming public debt loads, high taxation, relatively low rates of economic growth, and demographic graying. China has additional issues to contend with in the form of an immense accumulation of bad loans, capital flight, a lack of legitimacy and modern civic institutions, and the so-called middle income trap in which growth naturally slows.

Perhaps, for these reasons, a wrenching global economic crisis is just around the corner that will overwhelm central bank defenses and remedies as the Great Depression did. Or maybe the world’s industrial nations will contrive technological advances and their central banks will embrace sound policies that avert such a crisis. In thrall to gold buggery and neo-Marxist fantasies, neither Smith nor Wallerstein explored those questions.

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