Too late, the bank of central banks attacks their policies

The confidence in the ability of the major central banks to fix the mistakes from the period that predates the financial crisis has just been dealt a powerful blow. No, we are not talking about the collapse of the international stock markets over the last few days, but rather about an "attack" coming from the BIS (Bank for International Settlements) itself, meaning the bank of central banks.

Chief-economist Claudio Borio, and three other economists of the institution have published a study concerning the relationship between the accelerated growth of lending and the dynamics of labor productivity in developed economies, amid the reallocation of labor at the level of the economic sectors ("Labour reallocation and productivity dynamics: financial causes, real consequences", www.bis.org/publ/work534.htm). The study was conducted on a sample consisting of 21 advanced economies, whose development has been tracked from 1969 to the present day.

The author's conclusions undermine the entire structure built by the central to justify their ultra-lax monetary policies, enacted since the start of the international financial crisis.

"The lax monetary policy is an inefficient way to correct the flawed allocation of resources from the previous expansion period, because that was precisely what caused the flawed allocation in the first place", the BIS economists further state.

Their statement seems taken out directly from the writings of Ludwig von Mises, who, several decades ago, warned against the destructive nature of the explosive growth of lending. In his fundamental work, "Human action", Ludwig von Mises writes that "there are no means to avoid the final collapse of a boom caused by the expansion of credit".

Borio and his team explain the mechanism by which the flawed allocation of resources is felt especially after the beginning of the financial crisis. "A lending boom tends to undermine productivity by stimulating the reallocation of labor towards the sector where the increase in productivity is low", the BIS analysis writes. The example provided by authors is that of the construction sector, which sees an excessive expansion during the periods of accelerated lending growth.

"When economic circumstances become hostile, amid the onset of the crisis, the flawed allocation leads to further flawed allocations", the authors further write, because monetary policies try to prevent the correction of the imbalances.

The analysis also questions the hypothesis of secular stagnation, advanced by a series of economists which also include Larry Summers, former US Treasury Secretary.

According to that hypothesis, the US economy is facing a structural aggregated demand deficit, which has manifested itself even before the onset of the financial crisis. The economists of the BIS think that, to the contrary, "the weak recovery that followed the Great Financial Crisis is the result of a financial boom and of a financial collapse that has left deep wounds at the level of the economic organism". Also, "the disappointing economic performance of the United States before the crisis, despite a powerful financial boom, was disappointing, at least partially, precisely because of the financial boom".

Ambrose Evans-Pritchard writes, in The Telegraph, that "the BIS has implicitly condemned the Federal Reserve and the other central banks for perverting the interest rate policies in order to create demand where it wouldn't have been necessary", in other words an artificial demand based on the expansion of lending and the springing of a debt trap that has no way out.

"The BIS states that the entire strategy of the stimulus programs of the central banks relies on false premise", the British journalist further states, because "there doesn't seem to exist a deficit of aggregated demand, as per the hypothesis submitted by the authors of the study", and the main issue is the level of the supply, which is not reacting to the monetary stimulus.

In the opinion of Claudio Borio, the policy of central banks over the last quarter of a century has been asymmetrical when it comes to the evolution of the economy. In other words, there have been no interventions in the boom periods, and during the periods of economic slowdown all available means have been used to turn the situation around. The result was the continuous debt increase, which has turned into a trap, Evans-Pritchard further writes.

Under these circumstances, "after a while, monetary policy runs out of ammo", the chief-economist of the BIS further said.

Through a strange coincidence, on the very day the BIS study was published on the website of the institution, former president of the Federal Reserve Bank of Dallas and former member of the Federal Open Market Committee (FOMC) of the Federal Reserve, admitted, on a CNBC show, that "we have stimulated a significant increase of the exchanges to create the welfare effect".

We are talking about the stimulus through the zero-interest policy rate and of the quantitative easing programs. Unfortunately for the planners of the global economy, now "the Federal Reserve is a gigantic weapon but without ammunition", as stated by Robert Fisher.

The belated admission of the mistakes of the American central bank has probably caused the former Fed official to say that the blame for the recent collapse of the international stock markets doesn't lie with China.

But then who is guilty and when will they admit their actions and their ignorance and bear the consequences? Can we hope that anybody knows how to escape the debt trap, created by the central banks, without a new world war?