Central Banks Are Close to Centralizing Everything

One Reason Why Their Policy Isn't Working
September 26, 2016 Updated: September 26, 2016

Traders and investors hardly focus on company profits, yields, or economic data anymore. Instead, the market reacts purely on central banks. Will the Fed raise interest rates? Will the Bank of Japan (BoJ) buy more stocks? Will the European Central Bank (ECB) buy more corporate bonds?

“Nobody has visibility; private sector signals have died. The private sector has no idea what to do. The more aggressive the public sector becomes, the less visibility the private sector has. They don’t spend and invest the way they should,” says Macquarie strategist Viktor Shvets.

In fact, central banks have become so central they are destroying markets around the globe by buying up so many securities there are none left for private investors.

Take the BoJ for example. The central bank, an institution run by appointed bureaucrats, owned 60 percent of Japan’s market for Exchange Trade Funds (ETFs) at the end of June 2016. At that time, it was the largest shareholder in 81 of Japan’s biggest 225 companies, according to a Bloomberg report.

(Bank of Japan, Investment Trusts Association of Japan, Bloomberg)

At What Point Do You Have a Market Left?

In Europe, the ECB is on track to own 25 percent of the 7 trillion euro government bond market of the 19 members states that make up the Eurozone and close to hitting the limit of owning a third of the bonds in different markets like Germany.

In the United States, the Fed had owned 30 percent of the 10-year equivalent Treasury bonds in December of 2013 and had to stop its program of quantitative easing because there was a shortage among private investors.

“Price stability is very different from price control and they control prices. It seems absolutely absurd to me. At the end of the day, you can stabilize a price on different bonds by buying all of them. But at what point do you have a market? In a market, you usually have several participants, and they are buying and selling to each other. In Europe, you have several participants, and they all sell to their central bank,” says independent analyst Reggie Middleton of the BoomBustBlog.

In economic theory, the most competitive and therefore accurate market is one of perfect competition. An infinite number of buyers and sellers establish and equilibrium price. A market where you only have a few dominant players (oligopoly) or one buyer or seller (monopoly) leads to waste and inefficiencies.

Central bank buying of stocks and bonds is no different. Artificial demand from central banks inflates prices for stocks (BoJ) and bonds (Fed, ECB), thereby distorting market signals. How come Spanish ten-year government bonds can trade at a yield of 0.99 percent, only 1.07 percent above their German equivalents, which are far less risky. And how can German government bonds trade at a negative yield, guaranteeing losses for investors?

There is another problem with central bank policy, and this is the fundamental reason it is not feeding through to the real economy. Central banks buy these bonds and stocks with a special type of central bank currency, called bank reserves. They are created out of thin air; real companies or real people can’t use them.

(Stone & McCarthy Research Associates)

Fed Money

Only commercial banks can use that currency to trade with the central bank or with each other. So if the Fed buys a Treasury bond from JPMorgan for $100 for example, JPMorgan’s account at the Fed gets credited with a $100 of central bank money called “reserves.”

JPMorgan can then take that $100 credit to buy a corporate bond from Wells Fargo. But the $100 stays at the Fed, it merely goes from JPMorgan’s account to Wells Fargo’s account. The point is that this money never leaves the Fed and cannot be used in the real economy.

Banks could lend to real companies and people against these reserves. This hasn’t happened since the financial crisis of 2008 and is a big reason for the weak recovery. Sometimes banks don’t want to lend. Sometimes people and private companies don’t want to borrow.

(Bloomberg, ECB, ABN AMRO Group Economics)

So the Fed, the ECB, and the BoJ can buy up all the assets and eventually end up as the biggest shareholder and the biggest creditor to governments and corporates.

“They could essentially monetize everything, and then you have state ownership. And through the central banking system, you introduce socialism and communism, which is state ownership of production and consumption,” says Dr. Marc Faber, investor and publisher of the Gloom, Boom & Doom report.

If you think central banks are pillars of the capitalist system, and this will never happen, you should refer to point 5 in the communist manifesto. It calls for the “centralisation of credit in the hands of the state, using a national bank with state capital and an exclusive monopoly.”

Perhaps unwillingly, the central banks of the world are coming close to that scenario.