Central bankers fail to learn the Wellington lesson

Financial Events

Brent Sept12.png‘Masterly inactivity’ was Wellington’s policy in his successful European wars against Napoleon in the early 19th century. The English general was always under great pressure from the politicians to ‘do something’. But Wellington knew he had to defeat Napoleon decisively, and could not risk losing men and resources in irrelevant actions.

His Waterloo victory then settled Europe’s shape for the next 100 years.

200 years later, central bankers see themselves as the generals of our time. They talk about their fights with the speculators, and their battles with markets. But they have not learnt Wellington’s important lesson. Of course, the politicians will always cry out for ‘action’. But action can have unintended consequences, and make things worse, not better.

This is the theme of a new paper by one of the few great central bankers of recent years, William White. He is the former economic adviser at the Bank for International Settlements, the central bankers’ bank.

As long-standing readers will know, he was one of the very few to foresee the Crisis in his 2007 and 2008 reports. In 2009, he also foresaw today’s most difficult environment:

“Another boom-bust cycle could have negative implications, social and political, stretching beyond the sphere of economics”

Recently, both the US Federal Reserve and the European Central Bank (ECB) have announced further massive intervention in financial markets. White, as always, summarises the situation incisively:

“Over the past year, central banks in the advanced economies have continued or even expanded their purchases of government bonds and their support of liquidity in the banking system. At $18tn and counting, the aggregate assets of all central banks now stand at roughly 30% of global GDP, double the ratio of a decade ago.

“The extraordinary persistence of loose monetary policy is largely the result of insufficient action by governments in addressing structural problems. Simply put: central banks are being cornered into prolonging monetary stimulus as governments drag their feet and adjustment is delayed…. Any positive effects of such central bank efforts may be shrinking, whereas the negative side effects may be growing…. With nominal interest rates staying as low as they can go and central bank balance sheets continuing to expand, risks are surely building up.”

More liquidity will not solve the US and Eurozone problems. The US requires politicians to agree on medium to long-term policies that will bring the budget back to balance. The Eurozone needs governments to agree on economic and political union to support monetary union.

Even worse, the ECB and Fed actions are likely to likely to make the situation worse, not better. As the chart shows, speculators have already pushed oil prices higher over the past weeks, since news of the proposed new central bank cash was released. These higher prices will further destroy demand and reduce potential growth rates.

Plus, as Wellington knew, the central bankers’ activity has given the politicians yet another wonderful excuse for doing nothing.

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