Greece and China expose limits of 'whatever it takes'
From the United States to Europe and Asia, financial markets have been cowed, then calmed and are now coddled by the limitless power of central banks to print new money to ward off systemic shocks and deflation.Updated: Jul 08, 2015 15:40 IST
For a world so confident that central banks can solve almost all economic crises, the dramas unfolding in Greece and China are sobering.
"Whatever it takes," Mario Draghi's 2012 assertion about what the ECB would do to save the euro, best captures the all-powerful, self-aware central bank activism that's cosseted world markets since the banking and credit collapse hit eight years ago.
From the United States to Europe and Asia, financial markets have been cowed, then calmed and are now coddled by the limitless power of central banks to print new money to ward off systemic shocks and deflation.
But even if you believe central banks will do whatever it takes - to save the euro, stop the recession, create jobs, boost inflation, prop up the stock market and so on - it doesn't necessarily mean it will always work.
Draghi himself merely pleaded for faith on that score three years ago when he added, "Believe me, it will be enough."
Critically, given the direction of events in Athens, his celebrated epigraph was preceded by "Within our mandate..."
And so the prospect of the European Central Bank potentially presiding over, some say precipitating, the first national exit from a supposedly unbreakable currency union will inspire a rethink of the limits of Draghi's phrase for all central banks.
Of course, the ECB does not want to push Greece out of the euro. But 'whatever it takes' may just not be enough to preserve the integrity of the 19-nation bloc if the ECB's mandate prevents it from endlessly funnelling emergency funding to insolvent Greek banks.
And as long as the Greek government is at loggerheads with its creditors, the central bank can't wave a magic wand of monetary support without breaking its own rules.
The ECB continues to insist it will do all in its power to prevent contagion to other euro zone markets and there's little doubt it will make good on that. But the problems stemming from a Greek exit are not of financial seepage but of political contagion to other euro electorates tiring of austerity. And that sort of contagion is beyond ECB control.
Across the planet
Switch across the planet and another test of central banking determination and effectiveness is playing out.
The once awesome ability of the People's Bank of China to micro-manage the world's second largest economy and one of the globe's biggest stock markets is being sorely challenged.
Having helped inflate a bubble-like doubling of Shanghai stocks with easy money over the past year, the PBOC, along with government regulators, is now desperately trying to control a sudden implosion that's wiped 30% and $3 trillion off equity values in just three weeks.
The worrying bit is that after cutting interest rates and bank reserve requirements in late June and then last weekend injecting liquidity into a state-backed margin finance company, the PBOC barely got any market response.
Given that 85% of share trading in China is conducted by small retail investors, the economic ripples on consumer sentiment could be sizeable for an economy slowing to below 7% for the first time since the financial crisis.
Economists at Schroders point out, for example, that booming brokerage business saw a near doubling of the financial sector contribution to GDP growth to 1.3% in the first quarter.
But the loss of PBOC control, however temporary, asks yet another question of the omnipotence of central banks.
"If the PBOC fails to support its equity markets, it will be the first major central bank to have failed trying to influence the targeted asset markets," said Stephen Jen at hedge fund SLJ Macro Partners. "Investors could wonder if central banks in general may be approaching an inflection point with diminishing returns on their operations."
The point is not lost on those tasked with monitoring the world's central banks.
Economists at the Bank for International Settlements warned on June 28 that a loss of control by central banks, now painfully short of new ammunition to deal with either a major market crash or a sudden world downturn, was one of the most worrying threats to the world financial system.
"Monetary policy has been overburdened for far too long," the BIS said in its 85th annual report, arguing deep-seated economic reforms must now be stepped up to take the pressure off over-easy monetary policy and highly indebted governments.
"The likelihood of turbulence will increase further if current extraordinary conditions are spun out. The more one stretches an elastic band, the more violently it snaps back."
US and UK central banks, fearing zero rates are not only causing investment distortions but also societal problems due to ballooning wealth inequality, have indeed been flagging the likelihood of interest rate rises over the coming months.
But their ability to do whatever it takes to achieve that may be more clipped than it was when they were easing.
If China or a Greece-less euro zone were to blow up into another financial shock that hit global economic confidence, the Federal Reserve and Bank of England could well find themselves trapped at zero, having never reset interest rates during one of the longest financial bull markets in history. What happens at that point starts to look a bit scary.