Young Master Bernanke - Article from our DC Division

Granddad, Did You Believe in Central Banks Once?: Mark Gilbert 2007-06-20 19:14 (New York)


Commentary by Mark Gilbert
June 21 (Bloomberg) -- ``Granddad Benny, is it true that central bankers used to believe they could steer the global economy with quarter-point twitches in overnight rates?''
Granddad looked up from his GoogleSoft iSpreadsheet, where a flashing red ``health care'' box was blocking 2027's planned expenditure from matching the income cell. ``Yes, Joel. For about a decade we all believed central banks could ensure people had jobs, and could afford food and housing and such. That all changed after the Gigantic Global Bubble Burst of 2008.''
Joel put down his Mandarin dictionary. ``That's what my socio-economics teacher says we'll learn about next week. She called it the Giglobubu. What happened in 2008, Granddad?''
``We're still not sure, Joel,'' Granddad said. ``At the time, some accused the New Zealand central bank, some said it was the bond market, while others blamed the aftershocks of a slump in the U.S. housing market. If she's smart, your teacher will probably spend a lot of time talking about China.''
``Did China cause the Giglobubu, Granddad?''
``It played a big part, Joel. At the start of the century, China started to engage with the global economy. We were able to buy stuff like clothes and televisions really cheaply from China's factories, making everyone feel wealthy enough to spend and borrow instead of putting something aside for a rainy day.
``All of that borrowed money had to come from somewhere, and most of it came from Asia. When China stopped turning up at bond auctions in
2007 and started investing directly in companies instead, alarm bells should have rung. They didn't.

Billions of Spenders

``What everyone failed to realize was that the billions of people in China, Vietnam and other Asian countries didn't want to spend the rest of their lives living in huts in the countryside and working in factories for a pittance. They started to demand and get higher wages and a better standard of living, and went on a spending spree of their own. Their governments, meantime, built roads and hospitals and schools to keep people happy.
``Even though central bankers in the West had been puzzled by low bond yields and wage increases, they still took the credit for slow inflation! So when prices started to surge at the beginning of 2008, they were surprised when raising rates turned out to be powerless in the global economy. They were even more shocked when energy costs soared and they realized China controlled most of the world's power-producing capacity.''

Three Strikes and Out

Joel whispered ``2008 Giglobubu Causes'' into his Apple iWatch, and watched as the holographic multimedia display scrolled into life six inches above his wrist. ``Granddad, it says here that the New Zealand central bank made things worse?''
Granddad rubbed his beard as Joel's watch beamed graphs and charts into the air. ``Well, that's a bit unfair. They were quick to spot that prices were rising, and tried to curb inflation by driving up borrowing costs. Their mistake was trying to stop their currency, the New Zealand dollar, from rising. After the first two attempts failed, they should have given up. When the third attempt went wrong, people panicked because they started to realize how impotent the financial authorities were.''
``Granddad, it also says here that hedge funds and the derivatives market made things worse. What are hedge funds and the derivatives market?''
``Well, they are illegal now, Joel. As the global economy started to crumble under the weight of soaring raw material costs, financial markets melted down, with prices of stocks and bonds whipsawing. Hedge funds were supposed to be clever investors; it turned out that they had all made the same bet on the global economy staying wonderful for ever.

Tangled Webs

``Companies thought they'd borrowed money from their bankers.
Instead, hedge funds had bought up all of the IOUs. When companies started struggling to make their debt payments, instead of having a friendly chat with their bank managers, they found themselves eyeball-to-eyeball with the hedge funds' lawyers, who weren't interested in the survival of the companies and just wanted their money back.
``Lots of the banks had sold insurance on those IOUs and on a bunch of other stuff that they bundled together into derivatives called collateralized debt obligations. When those investments started to blow up, we all realized that nobody knew who owed what to whom. And banks and hedge funds had become such a big part of the global economy that they dragged everything else down with them.''
``I've been meaning to ask you, Granddad; what are all those funny little rectangles of green paper in that big frame on the wall next to your desk?''
``They're called dollars,'' Granddad said. ``We used them to buy things in the olden days. In 2015, a group called the Single Global Currency Association convinced the Bank for International Settlements, which by then was running the world's financial systems, that everyone should switch to one type of money.''
``And they didn't choose the dollar, Granddad?''
``No, Joel. There was a global referendum to make the decision on which currency people wanted. Which is why we now use the yuan all around the world. Anyway, it's getting late. Back to your Mandarin homework, young Master Bernanke.''

(Mark Gilbert is a Bloomberg News columnist. The opinions expressed are his own.)