Central bankers are trapped by their own policies

It’s unclear when it all started, but it has reached the point where it would make the biggest banker of all times, John Pierpont Morgan, turn in his grave.

In the world of finance, many quote his famous hearing in front of a House committee more than 100 years ago:

“Is not commercial credit based primarily upon money or property?”

“No sir. The first thing is character.”

“Before money or property?”

“Before money or property or anything else. Money cannot buy it … because a man I do not trust could not get money from me on all the bonds in Christendom.”

This is in fact the essence of markets and, more profoundly still, the essence of the world economy: confidence. The trouble is the “establishment”, the “elites”, those “in power,” the “policymakers” or whatever you want to call it, have forgotten how important it is.

Banks nowadays lend money mostly on quantitative criteria – credit scores based on the value, in money, of what a person can come up with in terms of collateral – without any regard to that person’s character.

Bankers are mostly on auto-pilot, because the Basel rules, with which they must comply, decide to whom they should predominantly lend (house buyers) and who they should consider a higher risk (businesses).

In good times, this type of almost robotic evaluation helped speed up the awarding of credit and therefore increased the money available for consumption.

In bad times… well, JP Morgan’s whole theory about character should apply: the banker should know his clients and know who will pay and who will not. Instead, what happened during the financial crisis of 2007-2009 was that central banks universally decided to bail out everybody, no matter how creditworthy or willing to pay. Well, almost everybody, anyway.

First, they cut interest rates to record lows. Then, as this was not enough to stop the panic, they started printing money. The initial purpose was noble — to keep things going until the economy nicely went back to growth.

The trouble is that things never go the way technocrats want them to. The human factor keeps getting in the way. And now the central bankers are trapped.

What happened was that, instead of using the great gift they got in the form of low interest rates and lots of money in the system to pay off their debt and sin no more, the ungrateful fools borrowed more. Those with one property borrowed against its rising value to buy another one, and another one, and another one, and on and on it went.

Add to this the Chinese, Russian, Middle Eastern capital looking for safe havens in property in Western Europe and in the big cities in the U.S., Canada and Australia, and you’ll see why central bankers are trapped.

They won’t admit it, but they’re hanging on every excuse possible to avoid raising interest rates. This is why we have negative yields on so many government and corporate bonds, and this is why work no longer pays.

We have had inflation, even hyper-inflation in some regions, but it has been in asset prices, not in consumer goods.

And finally, this is why ordinary people have lost their confidence in the system: they perceive it as rigged; bailing out the profligate debtors has in fact made them take on even more debt and become even “richer” while the frugal savers, who thought they were playing by the rules, got stung.

Character is forged by fighting and overcoming hardship and learning from mistakes, including financial ones, not by having every hardship taken away by a state keen to play God.

The loss of character in the markets and economy was caused by central bankers’ largesse — and now they are trapped.