Power Shift: First in a series on the rise of the central bankers and the global imposition of cheap credit


Quietly, without much public fuss or discussion, a new ruling class has risen in the richer nations.

These men and women are unelected and tend to shun the publicity hogged by the politicians with whom they co-exist.

They are the world's central bankers. Every six weeks or so, they gather in Basel, Switzerland, for secret discussions and, to an extent at least, they act in concert.

The decisions that emerge from those meetings affect the entire world. And yet the broad public has a dim understanding, if any, of the job they do.

In fact, these individuals now wield at least as much influence over the lives of ordinary citizens as prime ministers and presidents.

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© International Monetary FundSee the surge in central bank holdings, the printing of new money, beginning in the spring of 2008 with the bank bailouts and the acquisition of long-term securities to keep interest rates down.

The tool they have used to change the world so profoundly is one they alone possess: creating money out of thin air.

There is an economic term for this: quantitative easing. More colloquially, it's called printing money.

Since the great economic meltdown in 2008, these central bankers have probably saved the world's economy from collapse, and dragged it into the unknown at the same time.

The amounts they have created are so vast as to be almost incomprehensible - trillions of dollars in pounds and euros, among other currencies.

At the end of 2012, the balance sheets of the world's largest central banks, those of the G20 nations and the eurozone, including Sweden and Switzerland, totalled $17.4 trillion US, according to Bank of Canada calculations from publicly available data.

That is nearly a quarter of global GDP, and slightly more than double the $8.5 trillion these same institutions were holding at the end of 2007, before the financial crisis hit.

Stock markets have risen on this tide of cheap money. So has real estate. So, arguably, has everything else.

But there are two big concerns with what this new central banker elite has done.

One is that no one really understands the consequences of pumping such vast amounts of money into the world economy. It's already distorted the prices of certain assets, and some fear hyperinflation or market crashes are inevitable (the subject of tomorrow's column).

The other is that it's caused a massive shift in wealth, from savers to borrowers, and is taking money out of the pockets of almost everyone approaching or at retirement age.

A war on savings

Probably the most painful of the consequences of quantitative easing has been borne by the elderly.

Most of that generation grew up believing that if you save and exercise prudence that you will earn at least a modest return on your hard-earned money to keep you comfortable in your old age, perhaps along with a pension.

But the money-printing orgy of the last five years looks to have shot that notion to smithereens.

Very deliberately, the central bankers have punished savers, pushing interest rates so low that any truly safe investment - and older people are always advised to play it safe - yields a negative return when inflation is factored in.

The policy has savaged pension and savings returns worldwide, but particularly in Britain, a nation of savers and pensioners.

There is more money in British pension funds than in the rest of Europe combined, and now that money is just sitting, "dead," as some call it, not working for its owners.

Ask Judy White, a retiree in her late 60s who lives in Teddington, south of London, with her husband, Alan.

This year, the Bank of England shattered her retirement. Her pension benefit was effectively slashed by half.

"I don't understand what quantitative easing is, except that it's printing money," she says. "But I do understand that I now have 50 per cent less.

"What they have done is take money from people who have been really careful all their lives."

On the backs of the virtuous

Actually, by the Bank of England's own reckoning, the £375 billion of quantitative easing it has carried out since 2008 has cost British savers and pensioners about £70 billion, roughly $100 billion. (At the same time, the richest 10 per cent of British households saw the value of their assets increase over the same period, the bank reported.)

That cost to the elderly is largely because pension payouts in the U.K. are pegged to the yields on government bonds, and quantitative easing has forced those yields down to almost nothing.

Speaking for the Bank of England, Paul Fisher acknowledges that the bank has created a paradox: It does want people to save and be prudent - just not right now.

"We try," he says, "to get people to do things now to get out of this mess, which in the long run we prefer not to do."

In other words, might we please have some more of the wild consumer spending and borrowing that helped get us all into this situation, at least for a while?

The plain fact, though, is that central bank- and government-imposed solutions to disasters caused by irresponsible, greedy, foolish behaviour are almost always carried out on the backs of the virtuous.

So it was with the bank rescues in 2008, and so it is with quantitative easing.

As Ros Altmann, a longtime pension manager and director of the London School of Economics, puts it, quantitative easing has amounted to a "monumental social experiment" - a large-scale transfer of wealth from older people to younger people.

"Anybody who was a saver and has got some accumulated savings will have had a reduction in their income," she says.

While "anyone who had a big debt, particularly mortgage debts, would have had improvement in their income because their interest payments have gone down."

As stupid as it might sound, older people everywhere would probably be better off if they'd abandoned prudence and borrowed more.

That is obviously not what the central bankers or our political leaders want. But that's the situation they've created.

What's the alternative?

This transfer from savers to borrowers has also been taking place here in the U.S. and in Canada, to varying degrees.

Some U.S. pension funds are in danger of default, at least partially because of these artificially low interest rates, and Canadian pension funds that are heavily invested in safer debt have been injured, too.

In an interview in his Ottawa office, Bank of Canada governor Mark Carney defends quantitative easing elsewhere, and his own low-interest rate policy, though he does acknowledge that it has been hard on pensioners and savers.

Like all central bankers, he argues the (impossible to prove) negative: There have been consequences, yes, but if we hadn't done this, things would be far, far worse.

As for carrying out these solutions on the backs of the virtuous: "I don't see a world where the virtuous are rewarded if we suffered a second Depression," he says. "These are the stakes."

Carney would prefer not to talk about the enormous power central bankers have gained since 2008, saying only: "We have a tremendous responsibility ... because of a series of mistakes that were made in the private sector and the public sector."

As Canada has performed better than most Western nations, Carney has not ordered any new money printing.

But he has kept interest rates down, and that has fed the real estate booms over the last few years in Vancouver, Toronto, Calgary and elsewhere.

He scoffs at the suggestion that "the party" will end at some point. "I am not sure we are having a party right now," he says. "It doesn't feel like a party."

And, in fact, he has repeatedly expressed concern at the huge debt levels Canadians are accruing, at least partly because of his low-rate policies.

But surely he understands the anger of an older person watching their savings being eroded, I ask him.

Carney smiles grimly. That question is clearly a sore point. He gets a lot of mail on the topic.

Canadians, he says, must understand that the alternative is massive unemployment and thousands of businesses going under, and "my experience with Canadians is that they tend to think about their neighbours and their children and more broadly ... they care a little bit more than just about themselves."

Asked whether central bankers are not in fact enabling irresponsible behaviour by speculators enamoured of cheap money, not to mention politicians who can't curb their borrowing and spending, Carney merely remarks that voters in a democracy get the governments they choose.

Part 2: The illusion of growth
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© Associated Press / ReutersCheap credit is fuelling stock market runs and new home buying in much of North America. But in places like Spain, bank problems have led to repossessed homes, little construction and huge protests in the streets.
How central bank stimulus is creating a global 'bubble economy.' Power Shift, part 2

Mark Grant sits on the aft deck of his yacht in South Florida's spring sun, ostentatiously relishing his wealth as only an American does, and dispensing advice. He's made his money, and he likes to wear it.

Grant's personality is as big as his mansion and as flashy as his collection of exotic cars - he actually calls himself "The Wizard," a tribute to his own financial acumen.

While we are talking, his cellphone rings intermittently, and the callers are usually serious moneymen. Bill Gross of Pimco, the world's largest bond agency, is a friend; his praise adorns the dust jacket of Grant's recent book.

Inevitably, the callers are seeking investment advice.

A nearly 40-year Wall Street veteran, Grant is currently the managing director of a Texas-based investment bank and the author of a daily must-read investment commentary called Out of the Box.

His advice these days to tycoons and small investors alike is simple and direct. For heaven's sake, seek safety. Preserve your capital. "Keep what you have."

To Grant, the central banks' money printing has distorted the financial universe beyond any sensible dimensions.

The Federal Reserve alone is churning out $85 billion a month, or just over a $1 trillion a year. The combined balance sheets (which reflect created money) for the European Central Bank and the 17 individual banks of the eurozone stand at $3.45 trillion.

The Bank of England, the most energetic money printer in the world relative to the size of the economy it serves, has printed £375 billion (roughly $576 billion US), and is probably going to print more. The Bank of Japan has just launched an aggressive money-printing program of its own, planning to double the size of its balance sheet within two years.

In all, at the end of 2012, the balance sheets of the world's largest central banks, those of the G20 nations and the eurozone, including Sweden and Switzerland, totalled $17.4 trillion US, according to Bank of Canada calculations from publicly available data.

That is nearly a quarter of global GDP, and slightly more than double the $8.5 trillion these same institutions were holding at the end of 2007, before the financial crisis hit.

The idea behind all this central bank largesse is to reflate the world's money supply after the disastrous meltdown of 2008 and, at the same time, push interest rates down as far as possible in an attempt to get people - and companies - borrowing and spending again.

To date, however, the results have been mixed. The U.S. economy has been inching forward, while Britain's is teetering on a triple dip into recession. Much of Europe is also deep in recession and sinking under the weight of high unemployment.

Whether the massive money-printing program known as quantitative easing has prevented an even worse situation is debatable. But this much is certain: It's simply impossible to unleash such economic forces without serious consequences, intended and unintended.


Comment: It's also impossible that 'they' "unleashed" these economic forces to begin with - the seeds of destruction were sown long ago. See comment below for more information.


Bubble economies

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© Louis Deguise / CBCInvestment guru Mark Grant in Florida: It's a global bubble and the party is going to end soon.
Just about everyone agrees the Dow Jones industrial average - the measure of blue-chip America - did not reach an all-time high recently because of vibrant economic growth or fabulous performance by the companies listed in that index.

Markets are where they are principally because the Federal Reserve has been gobbling up U.S. treasury bills, the safest investment on Earth, in a deliberate attempt to force private investors into riskier assets, like stocks.

It's a high-stakes form of market engineering.

The Fed has been acting in rare concert with central banks worldwide to encourage borrowing and spending - and risk. And because all the new money being unleashed has to flow somewhere, it's been flowing, among other places, into the equity markets.

At the same time, the super-low interest rates resulting from all this money printing have heated up real estate markets in big cities worldwide - Toronto and Vancouver being perfect examples.

Grant says the markets and governments have developed an addiction to easy, cheap money to finance irresponsible borrowing.

"All this printing of money is creating a market that rests on a fantasy," he says.

For the first time ever, there isn't a single bubble out there, but an "entire world in a bubble. Every asset class, everything you can think of. Everything is in a bubble and something is going to prick it.

"The party," he says with great certainty, "is going to end."


Comment: Far from being "the first time ever", this is the same story that has played out again and again in history. What is different this time around is the scale of the overall bubble. We have 7 billion people and technology - particularly information technology - that has artificially extended the planet's carrying capacity.


An enormous bet

Think-tank economists, who rely on econometric models and speak a language so encoded as to be incomprehensible to most people, tend to look down their noses at analysts like Grant, referring to them as "the newsletter crowd."

But Grant has shown prescience. He was among the very first to predict Greece's financial implosion, and he has correctly pointed up the book-cooking and outright fraud in other eurozone economies.

He is also far from the only one contemplating a bad ending.

Recently, the Bank of International Settlement in Basel echoed Grant's concern that markets are developing an easy-money habit; and the International Monetary Fund just published a paper acknowledging the possibility of all this money printing (which it calls "monetary policy plus") creating widespread bubbles and difficult adjustments down the road.

Ros Altmann, a pension manager and a governor of the London School of Economics, compares quantitative easing to treating a sick patient with medication that doesn't work, and then, when the patient gets sicker, administering even more.

"It must stop," she says. "It is hugely dangerous. I think history will judge this period very harshly."

Still, the central bankers have at least as many fans as they do critics.

Don Johnston, the former president of the Treasury Board in the Trudeau government and a former director of the Organization for Economic Co-operation and Development, admires them greatly.

"I think they have more credibility than politicians," he says, "and it's been very fortunate that nearly all central banks are independent of the political arm."

Johnston concedes that the central banks' power at the moment is "immense." But he adds: "We had a big fire, and they absolutely had a critical role to play, and they played it, I think, extremely well."

Still, even Johnston, with his deep experience in government finances, allows that he doesn't fully understand the complexities of today's monetary policy, and the arguments for or against opening the spigots as much as they have been.


Comment: That's a big admission and one that should give pause for thought! Like studying the climate, it's ludicrous to believe that just one variable - CO2 emissions - can tell us which way things will go. It is complex, but a look at the historical 'cycles' of economic indicators in the rise and fall of civilizations tells us our modern 'boom' has only one place to go - down.


By acting in concert to push the world in the same direction, the central bankers have made some enormous bets. And, says Johnson, "they'd better be right."

The trouble is, they've been wrong in the recent past.

Central bank economic forecasts in recent years have sometimes been well off the mark, meaning they, too, can be acting on mistaken assumptions.

Also, even someone as seemingly omniscient as Alan Greenspan, the Federal Reserve chief through the Bill Clinton and George W. Bush years, publicly admitted his blunder in refusing to regulate the murky world of credit default swaps, which acted as accelerant in the 2008 disaster.

How to 'unwind'

Conservative economists have predicted for years that expanding the money supply will inevitably lead to inflation, or even hyperinflation. That, of course, has not happened in this instance, mainly because there's been so little economic growth and because the world is awash in the production of consumer goods.

But the big question, nearly everyone agrees, is whether the central banks can "unwind" the unprecedented situation they've created without massive disruption (not least to their own balance sheets, which are now stuffed with long-term, low-interest bearing bonds as part of the quantitative easing).

It's an impossible question to answer.

The financial markets scrutinize the abbreviated minutes after every meeting of the Federal Reserve committee that authorizes QE, looking for any sign money printing is about to end.

That ending would signal a rise, perhaps even a sharp one, in interest rates, which could hit the housing market hard.

Homeowners with only a small amount of equity and who are already stretched to the limit would be sorely stressed.

Significant interest rate changes could also affect banks, pension funds and insurance companies, as well as small businesses that have been relying on cheap credit to expand payrolls.

And higher interest rates would also slam into government budgets. Politicians have come to rely on cheap money to finance their borrowing and spending.

Of course, the top people at the Bank of England, the Federal Reserve and the Bank of Canada all argue a return to normalcy can be managed.

Just as the central banks have the power to create money, says Canada's Mark Carney, they have the power to pull money out of the system, and will, slowly, as growth returns.

They can begin selling off the assets they've bought with all this new money, and they have the all-important power to set central interest rates. If growth takes off, in fact, they will have to do those things in order to contain inflation.

But no "unwind" will happen soon, says Carney. "The repair is ongoing."

In Florida, Mark Grant tells his clients that there are no good endings to all this, "only less bad endings."

One of the big causes of the 2008 meltdown was too much cheap money, he notes, "and there's a lot more now."

Mainstream economists can't agree on whether an orderly unwind can happen. But then, as Don Johnston points out, "economists don't know what they don't know."

Meanwhile, the central bankers all seem to have landed on the same side of the issue, and are marching in step, urging people to borrow and spend for the good of all.

"Ultimately," says Carney, "history will judge whether we got this right."