The authorities are acting primarily to prop up governments as well as the economy by saving the financial system. It is important to remember these authorities are politicians and bureaucrats that want increased power and influence, and guess what, they may have hit the jackpot. Those in power have joined with the banks to create the "Financial-Political Complex" that promotes the current fiscal policy and supports banks that are "too big to fail". Many people say that the way out of the housing crisis is to let everyone fix their mortgage debt at super low fixed rates, then inflate, inflate, inflate? Well, perhaps the government's way out of its own debt is to secure low fixed rates for itself then inflate away when it becomes necessary.It should not bring comfort to the average man that these to unholy forces have joined together in such a union.
Who is the principal borrower at today's rates? The banks don't seem to be using the cheap money for their traditional business of lending, but it is the government that is doing the borrowing, and getting away with amazingly low rates for long-term debt. I wouldn't buy a 10 year Treasury at today's rates - I have no idea why others are doing it - unless it's the Chinese exporters who figure they still benefit. I bet the politicians can't believe their luck at being able to borrow and spend at these rates, the printing press is being used to keep the game going. As unstabilizing as the military and war can be to our lives, financial disruptions can also have devastating effects.
Banks have been big buyers of government bonds in the past couple of years because of the “carry trade,” this allows them to borrow money from the central banks at low rates and lend it back to the government at a higher yield. In effect, this is a subsidy to the banking sector. Banks may buy even more government bonds in future because international regulations assign a low capital charge to government debt and because banks will be required to hold a store of liquid assets, of which bonds will be a big part. So the government stands behind the banking system, and in turn, the banks are big buyers of government debt. This financial-political complex is reinforced by the general unwillingness of governments to let banks go bust. Better to intervene so heavily in markets, the argument runs, than do nothing and repeat the mistake of the Depression.
The cumulative effect of steps taken by the authorities over the past five years designed to prop up the economy and save the financial system has resulted in the creeping nationalization of markets. Central banks are the biggest players in many rich-world government-bond markets. Equity markets seem to perk up only when central banks are expanding the money supply. Banks exist to channel funds from savers to borrowers, traditionally from the household sector to companies. But modern banks raise funds not just from retail deposits, but also from the markets. Until 2007, European banks were able to borrow more cheaply from the markets than the better corporate borrowers. But for the past five years, banks’ borrowing costs have been consistently higher than those of non-financial firms. This raises huge question-marks over the banks’ role as intermediaries.
Loans from the official sector are being used to reduce the impact of private-sector capital flight. Huge amounts of money have left Spain and Italy, largely as foreigners withdrew bank deposits or sold government bonds. The net effect is that several countries are substantial debtors of the ECB, while Germany, Finland, and Luxembourg are net creditors. Money is flowing across borders at record rates. Funding pressures have been relieved by massive amounts of liquidity from central banks. Private-sector funding has been replaced with official lending. Central banks have been “lenders of last resort” for banks since the mid-19th century making short-term loans made at moments of panic. This time the ECB has lent a staggering €1 trillion ($1.3 trillion) on a three-year basis. The hope is that these loans can be refinanced via the private sector in 2014 or 2015. But this may be too sanguine. The funding woes of banks are already almost five years old.
The bond market has never been fully free of central-bank influence: expectations about the future level of short-term rates have always influenced yields. But the Federal Reserve has said that it will keep rates at current low levels until late 2014, an unprecedented commitment. Central banks have been putting downward pressure on yields through substantial quantitative easing (QE) programs. The Bank of England owns almost a third of the gilt market, this means that yields are not set solely by the balance of supply and private-sector demand.
Nor is this the only rigged market. Many countries are following policies that are designed to drive the value of their currencies down. And the authorities are helping to prop up share prices: Ben Bernanke, chairman of the Fed, has welcomed a higher stock-market as a side-effect of QE. As a result, it is difficult to say what message the markets are sending. Do low bond yields show that investors are endorsing Britain’s deficit-reduction program, for example? Or do they mean that the government has plenty of room to ease fiscal policy and borrow more? Thanks to QE, it is hard to be sure.
History suggests that once governments get involved in a sector, they find it hard to withdraw. Given the weak outlook, it is hard to imagine the circumstances in which liquidity support for the banks will be withdrawn, or the policy of low-interest rates abandoned. This is a new financial and economic era. QE and ZiRP haven't forced investment but rather sent people running for cover. More of the same is not a resolution to deep-rooted problems but does represent the evil character of finance for the moment.
I predict a financial washing machine in the near future that will repeatedly agitate, rinse, spin, and strip away the wealth and savings of most citizens. It seems to me there is every chance that in time the people and the market will regain control of money from big banks and governments, after all, banks only exist to distribute money, and for this minor service they are paid exorbitantly well. The character of money is changing with technology, that determines who can raise it, and how it is exchanged. It will take time as our culture changes but technically we no longer need banks or even the government for this. We should be very afraid of the "Financial-Political Complex" and the current policies because both have disaster written all over them.
Thanks for reading this post, if you haven't had enough or can stomach a bit more;