How the Central Banks May Bring About Another Economic Implosion

“Conjured money” issued by central banks is one of the strategies at the heart of the vulnerability of the banking system. Nomi Prins explains in this excerpt from Collusion.

It is not the responsibility of the Federal Reserve — nor would it be appropriate — to protect lenders and investors from the consequences of their decisions.

— Ben Bernanke, Federal Reserve chairman, 2007

The 2007-2008 US financial crisis was the consequence of a loosely regulated banking system in which power was concentrated in the hands of too limited a cast of speculators. Since the crisis, G7 central banks have pumped money into private banks through an unconventional monetary policy process called quantitative easing (QE). QE is an overtly complex term that entails a central bank manufacturing electronic money and then injecting it into banks and financial markets in return for purchasing bonds or securities (or stocks). The result of this maneuver is to lift the money supply within the financial system, reduce interest rates (or the cost of borrowing money, disproportionally in favor of the bigger banks and corporations), and boost the value of those securities. The whole codependent cycle is what I call a “conjured-​money” scheme, wherein the cost of money is rendered abnormally cheap.

Speculation raged in the wake of this abundant cheap capital much as a global casino would be abuzz if everyone gambled using someone else’s money. Yet bank lending did not grow, nor did wages or prosperity, for most of the world’s population. Instead, central bankers created asset bubbles through their artificial stimulation of banks and markets. When these bubbles pop, the fragile financial system and economic world underlying them could be thrown into an economic depression. That’s why central banks are so desperate to collude.

Enabling certain banks to become “too big to fail” was the catastrophic mistake of the very body supposed to keep this from happening, the Federal Reserve. The Fed happens to be the arbiter of bank mergers — and it has never seen a merger it didn’t like. Legislation to deter “too big to fail” had been in existence since 1933. In the wake of the Great Crash of 1929, a popular bipartisan act called the Glass-​Steagall Act restricted banks from using federally insured customer deposits as collateral for large-​scale speculation and asset creation. Banks that were engaged in both of these types of practices, or commercial banking and investment banking, were required to pick a side. Either service deposits and loans, or create securities and merge companies and speculate. By virtue of having to choose, they became smaller. Big bank bailouts became unnecessary. But that act was repealed in 1999 under President Clinton. As a result, banks went on a buying spree. The larger ones gobbled up the smaller ones. Along the way, their size and loose regulations gave them the confidence and impetus to engage in riskier practices. Ultimately, they became so big and complex that they could create toxic assets and provide financing to their customers to buy them, all at once.

That’s how the subprime mortgage problem became a decade-​long financial crisis that required multiple central banks to contain it. Big banks could buy up mortgages, turn them into more complex securities, and either sell them to global customers, including pension funds, localities, and insurance companies, or lend substantive money to investment banks and hedge funds that engaged in trading these securities. The Fed allowed all of this to happen.

Massive leveraging (or betting with huge sums of borrowed money) within the securities those big banks created and sold exacerbated the risk to which they exposed the world. Eight years after the crisis began, the Big Six US banks — JPMorgan Chase, Citigroup, Wells Fargo, Bank of America, Goldman Sachs, and Morgan Stanley — collectively held 43 percent more deposits, 84 percent more assets, and triple the amount of cash they held before. The Fed has allowed the biggest banks on Wall Street to essentially double the risk that devastated the system in 2008.

But in the banks’ moment of peril, the Fed unleashed a global policy of injecting fabricated money into the worldwide financial system. This flood of cheap money resulted in the subsequent issuance of trillions of dollars of debt, pushing the global level of debt to $325 trillion, more than three times global GDP.1 By mid-​2017, the total assets held by the G3 central banks — the US Fed, the European Central Bank (ECB), and the Bank of Japan (BOJ) — through conjured-​money QE programs had hit more than $13.5 trillion. The figure was equivalent to 17 percent of currency-​adjusted global GDP.

To garner support for their multi-​trillion-​dollar QE strategies, the G3 central bank leaders peddled the notion that they were helping the general economy. That couldn’t have been further from the truth. There was no direct channel, no law, no requirement to divert the Fed’s cheap money into helping real people. This was because borrowing and subsequent investing in the real economy required funds from private banks, and not from central banks directly. That’s how the monetary system was set up. And private banks were under no obligation to do anything with this cheap money they didn’t want to do.

Central bank money crafters realized early on that simply adjusting benchmark interest rates in their countries was no longer effective without quantitative easing. They had to wax unconventional with monetary policy. And then they had to collude to spread their programs globally. They concocted and plowed cash into their respective banking systems.

Specifically, the largest private banks, including JPMorgan Chase, Deutsche Bank, and HSBC, that inhaled this cheap money were not required to increase their lending to the Main Street economy as a condition of the availability of that money. Instead, the banks hoarded the cash. US banks colluded with the Fed to get that cash by stashing their bonds as “excess reserves” (more reserves for emergencies than regulations required) on the Fed’s books. And, because of the Emergency Economic Stabilization Act of 2008, they received 0.25 percent interest per year from the Fed on those reserves, too. Wall Street used its easy access to cheap money to increase speculation in derivatives and other complex securities. They used it to buy back their own shares, thus effectively manipulating their own stock — in broad daylight and with explicit approval from the Fed. In turn these banks dialed back their lending to small and midsized businesses, which hampered their growth potential.

The danger with having a system rely on so much conjured capital is that when central bankers stop manifesting it, it could go into shock; markets could plunge, credit seize, and a new crisis emerge. That’s why central banks are walking the tightrope between altering their policies and doing nothing to alter them, thereby continuing them by default, with no exit plan.

Copyright (2018) by Nomi Prins. Not be republished with permission of the publisher, Nation Books, an imprint of the Hachette Book Group.