Central Banks Have Violated Fundamental Laws of Finance

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By EconMatters

Is Monetary Policy Too Complicated for Mainstream to Understand?

It is amazing how far Central Banks have been allowed to go with regard to policy tools and influence, and how extreme their policy measures have become since the financial crisis. No other form of governmental authority has been granted these types of unrestrained powers in any branch of government, not Congress, the Supreme Court, the President, or the Military for comparison`s sake in the United States.

These policy measures really are the perfect example of taking maybe what may be an effective policy tool in strategic, but rare instances and adopting it as an everyday, cure all that becomes standard operating procedure for a banking, finance and monetary system.


Healthy Financial Infrastructure

It has been said that a modern civilization needs a banking infrastructure to fully realize its potential, and grow from a business and economic standpoint that represents the modern capitalistic model which has greatly improved human technological, creative and individual prosperities.

Central Banks & “Monetary Extremism”

However, the last seven years of Central Bank actions, and the last 6 months in particular with the ECB`s actions to enact extreme monetary measures, the Federal Reserve making excuse after excuse to defer normalizing monetary policy, the Bank of Japan just experimenting with monetary policy solutions, and the recent cascade effects on other central banks to lower their rates to combat the side effects of the first movers “monetary extremism” it has become abundantly clear to all but the politicians that central banks are no longer the all-knowing saviors of the financial system, but in fact have gone off the deep end, left to their own unregulated devices, and have become a large part of the problems in and of themselves.

Basic Finance Principles the Starting Point for Economic Theory

There is a major distinction between economic theory, and finance theory but let`s get this one thing straight, economic theory starts with finance theory, and not the other way around. There are certain immutable laws of finance that should never be violated under most circumstances, even for a few months; let alone let to stand as permanent fixtures of the monetary system in a capitalistic system.

ZIRP is the main problem with the global economy right now, and all the central banks are doing the exact opposite of what they should be doing, which is normalizing rates, developing a functioning yield curve which every modern lending system since the beginning of a banking infrastructure and finance community has relied upon to fully respect capital, and allocate capital to its most efficient pro-growth projects in society.

Japan ZIRP Model Failed 

Just take Japan they have tried this ZIRP model for over 20 years, it is a complete failure, remember when Japan was the rising giant of the East, and now the BOJ has gone completely rogue, well not according to the Krugman’s and the Bernanke`s of the world, which is where this whole modern ZIRP Economic Garbage of a theory went to the dark side in what I label “Modern Monetary Extremism”.

Monetary Extremism: Like Having a Military Draft in Peace Time

If this happened in any other area of society take it the military, Supreme Court, a religion, a school board it would all have been rejected thoroughly by society, extremism of this magnitude is usually rejected in Democratic societies.

Yes it is extremism Paul Krugman, one doesn`t take emergency measures and then implement these measures for seven straight years, the equivalent of an entire business cycle in some cases, to the point that they become the actual basis for the financial principles that make up the monetary system of banking, lending and commerce.

Negative Real Rates a Big Problem for Central Banks

All one has to do is look at the negative real rates of the bond market to see the improper allocation of capital in the financial monetary system, in short the immutable laws of financial theory have been violated, and this is a problem for a functioning, and healthy capitalistic system. Remember economic theory comes from finance principles not the other way around, the economists of the world have completely ruined the financial system. The damage they have wrought on the financial system is far worse than the original financial crisis they were trying to fix. Gosh we only had a recession which we have had many in the history of the world, but now we are stuck with dysfunctional and socialized financial markets, the most basic strike against everything financial markets and capitalism stands for!

Capital Allocation, Productive Growth & Negative Real Rates of Return on Investment

When I look at all the negative real rates around the world, and how much money, trillions and trillions of dollars chasing yield opportunities in electronic markets instead of this capital actually being incentivized by a normal functioning rate structure and curve in the global bond markets where normal finance relationships that have stood since the beginning of modern business transactions it is apparent that central banks need to actually start normalizing rates, and not lowering them because the zero bound is detrimental when utilized past 6 months to a year at the most in extreme emergency situations. ZIRP keeps money from actually getting out into the real world, and ends up incentivizing more capital searching for Yield in highly insulated financial markets, this capital never reaches the ‘real Economy’.

Zero-Bound is Deflationary Monetary Policy 

I am not saying the Fed Fund`s Rate should be raised to 10% and higher is better, that is the extreme in the opposite direction. But this ZIRP Love Affair and Obsession got way ahead of its usefulness, and it was bad enough when Japan was the only country in the world going down this path, which should have served as a cautionary tale to the Krugman and Bernanke`s of the economic elite in this country, but the “Japanification” of the entire global monetary system, is the biggest problem the global economy faces right now. It incentives unproductive and highly inefficient uses of capital allocation strategies, and is actually deflationary, which is ironic because this is the very reason used for going down this extreme monetary path in the first place!

A healthy 3% Fed Fund`s Rate Allocates Capital in More Productive Growth Oriented Projects

I know it is counter-intuitive to what these economists believe, but a healthy 3% Fed Funds Rate will go a long way towards restoring basic financial principles and relationships in the broader economic system. It will promote much more productive uses of capital, in a sense respecting capital, and restoring the necessary healthy financial relationships needed for stimulating productive growth in the global economy. Negative Real Rates are a problem for central banks, certain basic fundamental finance principles must be respected at all times, and one of them is that a healthy banking, lending and properly functioning monetary system must always have positive real rates of return on investment. It serves as the basis for any healthy allocation of capital within a given society that promotes long-term growth initiatives. ZIRP in essence is deflationary in nature, it becomes a self-fulfilling, reinforcing slippery slope of “Monetary Extremism” and should be rejected at all costs!

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