Capital in the Twenty-First Century (96 page)

What happens next depends on how this monetary policy influences the real economy.
If the loan initiated by the central bank enables the recipient to escape from a bad
pass and avoid a final collapse (which might decrease the national wealth), then,
when the situation has been stabilized and the loan repaid, it makes sense to think
that the loan from the Fed increased the national wealth (or at any rate prevented
national wealth from decreasing). On the other hand, if the loan from the Fed merely
postpones the recipient’s inevitable collapse and even prevents the emergence of a
viable competitor (which can happen), one can argue that the Fed’s policy ultimately
decreased the nation’s wealth. Both outcomes are possible, and every monetary policy
raises both possibilities to one degree or another. To the extent that the world’s
central banks limited the damage from the recession of 2008–2009, they helped to increase
GDP and investment and therefore augmented the capital of the wealthy countries and
of the world. Obviously, however, a dynamic evaluation of this kind is always uncertain
and open to challenge. What is certain is that when central banks increase the money
supply by lending to a financial or nonfinancial corporation or a government, there
is no immediate impact on national capital (both public and private).
²⁰

What “unconventional” monetary policies have been tried since the crisis of 2007–2008?
In calm periods, central banks are content to ensure that the money supply grows at
the same pace as economic activity in order to guarantee a low inflation rate of 1
or 2 percent a year. Specifically, they create new money by lending to banks for very
short periods, often no more than a few days. These loans guarantee the solvency of
the entire financial system. Households and firms deposit and withdraw vast sums of
money every day, and these deposits and withdrawals are never perfectly balanced for
any particular bank. The major innovation since 2008 has been in the duration of loans
to private banks. Instead of lending for a few days, the Fed and ECB began lending
for three to six months: the volume of loans of these durations increased dramatically
in the last quarter of 2008 and the first quarter of 2009. They also began lending
at similar durations to nonfinancial corporations. In the United States especially,
the Fed also made loans of nine to twelve months to the banking sector and purchased
long-dated bonds outright. In 2011–2012, the central banks again expanded the range
of their interventions. The Fed, the Bank of Japan, and the Bank of England had been
buying sovereign debt since the beginning of the crisis, but as the debt crisis worsened
in southern Europe the ECB decided to follow suit.

These policies call for several clarifications. First, the central banks have the
power to prevent a bank or nonfinancial corporation from failing by lending it the
money needed to pay its workers and suppliers, but they cannot oblige companies to
invest or households to consume, and they cannot compel the economy to resume its
growth. Nor do they have the power to set the rate of inflation. The liquidity created
by the central banks probably warded off deflation and depression, but the economic
outlook in the wealthy countries remains gloomy, especially in Europe, where the crisis
of the euro has undermined confidence. The fact that governments in the wealthiest
countries (United States, Japan, Germany, France, and Britain) could borrow at exceptionally
low rates (just over 1 percent) in 2012–2013 attests to the importance of central
bank stabilization policies, but it also shows that private investors have no clear
idea of what to do with the money lent by the monetary authorities at rates close
to zero. Hence they prefer to lend their cash back to the governments deemed the most
solid at ridiculously low interest rates. The fact that rates are very low in some
countries and much higher in others is the sign of an abnormal economic situation.
²¹

Central banks are powerful because they can redistribute wealth very quickly and,
in theory, as extensively as they wish. If necessary, a central bank can create as
many billions as it wants in seconds and credit all that cash to the account of a
company or government in need. In an emergency (such as a financial panic, war, or
natural disaster), this ability to create money immediately in unlimited amounts is
an invaluable attribute. No tax authority can move that quickly to levy a tax: it
is necessary first to establish a taxable base, set rates, pass a law, collect the
tax, forestall possible challenges, and so on. If this were the only way to resolve
a financial crisis, all the banks in the world would already be bankrupt. Rapid execution
is the principal strength of the monetary authorities.

The weakness of central banks is clearly their limited ability to decide who should
receive loans in what amount and for what duration, as well as the difficulty of managing
the resulting financial portfolio. One consequence of this is that the size of a central
bank’s balance sheet should not exceed certain limits. With all the new types of loans
and financial market interventions that have been introduced since 2008, central bank
balance sheets have roughly doubled in size. The sum of the Federal Reserve’s assets
and liabilities has gone from 10 to more than 20 percent of GDP; the same is true
of the Bank of England; and the ECB’s balance sheet has expanded from 15 to 30 percent
of GDP. These are striking developments, but these sums are still fairly modest compared
with total net private wealth, which is 500 to 600 percent of GDP in most of the rich
countries.
²²

It is of course possible in the abstract to imagine much larger central bank balance
sheets. The central banks could decide to buy up all of a country’s firms and real
estate, finance the transition to renewable energy, invest in universities, and take
control of the entire economy. Clearly, the problem is that central banks are not
well suited to such activities and lack the democratic legitimacy to try them. They
can redistribute wealth quickly and massively, but they can also be very wrong in
their choice of targets (just as the effects of inflation on inequality can be quite
perverse). Hence it is preferable to limit the size of central bank balance sheets.
That is why they operate under strict mandates focused largely on maintaining the
stability of the financial system. In practice, when a government decides to aid a
particular branch of industry, as the United States did with General Motors in 2009–2010,
it was the federal government and not the Federal Reserve that took charge of making
loans, acquiring shares, and setting conditions and performance objectives. The same
is true in Europe: industrial and educational policy are matters for states to decide,
not central banks. The problem is not one of technical impossibility but of democratic
governance. The fact that it takes time to pass tax and spending legislation is not
an accident: when significant shares of national wealth are shifted about, it is best
not to make mistakes.

Among the many controversies concerning limiting the role of central banks, two issues
are of particular interest here. One has to do with the complementary nature of bank
regulation and taxation of capital (as the recent crisis in Cyprus made quite clear).
The other has to do with the increasingly apparent deficiencies of Europe’s current
institutional architecture: the European Union is engaged in a historically unprecedented
experiment: attempting to create a currency on a very large scale without a state.

The primary and indispensable role of central banking is to ensure the stability of
the financial system. Central banks are uniquely equipped to evaluate the position
of the various banks that make up the system and can refinance them if necessary in
order to ensure that the payment system functions normally. They are sometimes assisted
by other authorities specifically charged with regulating the banks: for example,
by issuing banking licenses and ensuring that certain financial ratios are maintained
(in order to make sure that the banks keep sufficient reserves of cash and “safe”
assets relative to loans and other assets deemed to be higher risk). In all countries,
the central banks and bank regulators (who are often affiliated with the central banks)
work together. In current discussions concerning the creation of a European banking
union, the ECB is supposed to play the central role. In particularly severe banking
crises, central banks also work in concert with international organizations such as
the IMF. Since 2009–2010, a “Troika” consisting of the European Commission, the ECB,
and the IMF has been working to resolve the financial crisis in Europe, which involves
both a public debt crisis and a banking crisis, especially in southern Europe. The
recession of 2008–2009 caused a sharp rise in the public debt of many countries that
were already heavily indebted before the crisis (especially Greece and Italy) and
also led to a rapid deterioration of bank balance sheets, especially in countries
affected by a collapsing real estate bubble (most notably Spain). In the end, the
two crises are inextricably linked. The banks are holding government bonds whose precise
value is unknown. (Greek bonds were subjected to a substantial “haircut,” and although
the authorities have promised not to repeat this strategy elsewhere, the fact remains
that future actions are unpredictable in such circumstances.) State finances can only
continue to get worse as long as the economic outlook continues to be bleak, as it
probably will as long as the financial and credit system remains largely blocked.

One problem is that neither the Troika nor the various member state governments have
automatic access to international banking data or what I have called a “financial
cadaster,” which would allow them to distribute the burdens of adjustment in an efficient
and transparent manner. I have already discussed the difficulties that Italy and Spain
faced in attempting to impose a progressive tax on capital on their own in order to
restore their public finances to a sound footing. The Greek case is even more extreme.
Everyone is insisting that Greece collect more taxes from its wealthier citizens.
This is no doubt an excellent idea. The problem is that in the absence of adequate
international cooperation, Greece obviously has no way to levy a just and efficient
tax on its own, since the wealthiest Greeks can easily move their money abroad, often
to other European countries. The European and international authorities have never
taken steps to implement the necessary laws and regulations, however.
²³
Lacking tax revenues, Greece has therefore been obliged to sell public assets, often
at fire-sale prices, to buyers of Greek or other European nationalities, who evidently
would rather take advantage of such an opportunity than pay taxes to the Greek government.

The March 2013 crisis in Cyprus is a particularly interesting case to examine. Cyprus
is an island with a million inhabitants, which joined the European Union in 2004 and
the Eurozone in 2008. It has a hypertrophied banking sector, apparently due to very
large foreign deposits, most notably from Russia. This money was drawn to Cyprus by
low taxes and indulgent local authorities. According to statements by officials of
the Troika, these Russian deposits include a number of very large individual accounts.
Many people therefore imagine that the depositors are oligarchs with fortunes in the
tens of millions or even billions of euros—people of the sort one reads about in the
magazine rankings. The problem is that neither the European authorities nor the IMF
have published any statistics, not even the crudest estimate. Very likely they do
not have much information themselves, for the simple reason that they have never equipped
themselves with the tools they need to move forward on this issue, even though it
is absolutely central. Such opacity is not conducive to a considered and rational
resolution of this sort of conflict. The problem is that the Cypriot banks no longer
have the money that appears on their balance sheets. Apparently, they invested it
in Greek bonds that were since written down and in real estate that is now worthless.
Naturally, European authorities are hesitant to use the money of European taxpayers
to keep the Cypriot banks afloat without some kind of guarantees in return, especially
since in the end what they will really be keeping afloat is Russian millionaires.

After months of deliberation, the members of the Troika came up with the disastrous
idea of proposing an exceptional tax on all bank deposits with rates of 6.75 percent
on deposits up to 100,000 euros and 9.9 percent above that limit. To the extent that
this proposal resembles a progressive tax on capital, it might seem intriguing, but
there are two important caveats. First, the very limited progressivity of the tax
is illusory: in effect, almost the same tax rate is being imposed on small Cypriot
savers with accounts of 10,000 euros and on Russian oligarchs with accounts of 10
million euros. Second, the tax base was never precisely defined by the European and
international authorities handling the matter. The tax seems to apply only to bank
deposits as such, so that a depositor could escape it by shifting his or her funds
to a brokerage account holding stocks or bonds or by investing in real estate or other
financial assets. Had this tax been applied, in other words, it would very likely
have been extremely regressive, given the composition of the largest portfolios and
the opportunities for reallocating investments. After the tax was unanimously approved
by the members of the Troika and the seventeen finance ministers of the Eurozone in
March 2013, it was vigorously rejected by the people of Cyprus. In the end, a different
solution was adopted: deposits under 100,000 euros were exempted from the tax (this
being the ceiling of the deposit guarantee envisioned under the terms of the proposed
European banking union). The exact terms of the new tax remain relatively obscure,
however. A bank-by-bank approach seems to have been adopted, although the precise
tax rates and bases have not been spelled out explicitly.