Banks’ cheap money is economic ‘poison’

March 11th, 2011

By Ron Robins

Developed world bankers believe that continued ultra-low interest rates—cheap money—and flooding markets with liquidity will ensure that their institutions and their countries will soon return to economic prosperity. But didn’t the same policies a few years ago help bring us financial ruin and economic collapse?

Have the bankers forgotten that it was access to cheap and easy money that drove many US and European banks to transform themselves into gambling institutions, eventually failing and having to be bailed out at taxpayers’ expense? And above all, that cheap and easy money enticed people, companies and governments, to become horribly indebted, causing many individuals and companies to fail?

Soon, even developed country governments may go bankrupt. As proof that cheap easy money is again storing up extraordinary economic problems, just look at where some of it is now going—into the commodities market. There, it helps inflate food and energy prices, causing starvation and food riots around the world.

Do the bankers not read history or know that artificially cheap money can be economic poison?

Of course one simple reason that many bankers advocate loose monetary policy is that it makes them a lot of money. When they can—as they did for many years and still seem able to do—‘leverage-up’ their assets in relation to their equity, they can make multiples of profits compared to before. And since, often courtesy of benevolent central banks, they can borrow at nearly free rates and ‘invest’ those proceeds in bonds/securities/commodities that often offer high potential returns, they don’t need to be geniuses to make ever bigger profits.

The assets of most large US and European banks exceeded their equity by 20 to 60 times before the financial crisis. That is, keeping it simple, they were somehow able to leverage every $1 of equity, usually by borrowing funds, to create $20 to $60 of assets! The risk of having such high leverage is that a small loss in asset values of say, just 5%, could wipe out their equity base and cause insolvency and bankruptcy.

Unfortunately,  leverage ratios remain very high in many developed countries’ banking systems. (Perhaps this is the real unspoken reason for cheap money: to inflate asset markets to keep the banks semi-solvent).

Therefore,  the culture at numerous developed-world banks remains one of leverage and risk-taking, and it’s thanks to abundant and cheap money. This is in contrast to the situation during much of banking history, when money was regularly relatively expensive (with higher rates of interest) than today and often much harder to obtain.

Continued ultra-loose monetary policy and quantitative easing are creating tremendous ‘moral hazard’ for bankers and other market participants. The culture remains one of taking large bets—and not caring if these go wrong, since losses can be palmed off on the taxpayer. Bankers under the influence of moral hazard are like addicted gamblers, who cannot stop gambling.

The US and European governments and central banks have sought to make light of the burdens they’ve taken on since the crash of September-October 2008, believing that as their economies recover, these losses will be greatly reduced. However, the ‘central bank of central banks,’ the Bank for International Settlements (BIS), has issued new global bank regulations (Basel III) which—if implemented—might rein in some of the excesses associated with moral hazard.

Of course not all banks speculate or gamble to the same extent. In Islamic banking, spiritual and ethical considerations greatly restrain speculation. Also, for instance, Canadian banks adhere to more conservative principles and are better regulated and so have not suffered the same fate as that of many of their US and European rivals.

For now though, cheap and easy money is seen by bankers as economic salvation. And it inflates global markets, including those related to food and energy. As prices of these essentials rise, the bankers’ wall of money triggers unforeseen consequences including starvation, food riots, and political upheaval around the globe.

Furthermore, the continuing high leverage, moral hazard, and gambling tendencies within the banking and financial system will ensure that some of today’s ‘good’ investments sour and suffer large losses. Will the taxpayers again assume those losses? If not, then what? Until the poison of cheap and easy money is removed, it will continue to create the conditions  for even bigger economic and social catastrophes in the years to come.

E-mail the writer: r.robins@alrroya.com

This is an edited version of an article by Ron Robins first published on the alrroya.com website.  Copyright IMedia LLC. Alrroya is an Arabic and English language business newspaper and news portal based in the UAE

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