Author: Kristina Hooper (Chief Global Market Strategist)
The United States has always had a difficult, complicated relationship with the concept of central banks. Early on, critics sought to prevent the establishment of a US central bank, while today, politicians in the US and around the world seek to use central banks as tools to further their policy aims. In my view, central bank independence is critical to their ability to counteract the economic effects of geopolitical chaos.
An idea mired in controversy
After the US broke away from England through its successful War of Independence, it was encumbered by a heavy debt load. In an attempt to alleviate that burden and create a unified fiscal agent, Alexander Hamilton proposed a Bank of the United States inspired by the Bank of England, and it was established in 1791. However, there were many critics — not the least of whom was Thomas Jefferson — who feared a powerful federal government that would ignore states’ rights and put mercantile interests ahead of agrarian interests.
Ultimately, “the Bank was doomed by the rise of the anti-federalists, both in the White House, in the person of James Madison, and in Congress.”1 When its charter came up for renewal in 1811, it was voted down by just one vote in each chamber of Congress.
But then came the War of 1812, which was followed by more burdensome debt as well as inflation, culminating in some banks suspending operations. This caused President James Madison to view the concept of a central bank more favorably, and so the Second Bank of the United States was chartered in 1816. And it was successful at containing inflation and muting the excesses of the business cycle; in addition, this central bank’s notes were widely accepted in America as a common currency. However, it met a similar fate as that of the first American central bank thanks to President Andrew Jackson who, despite Congress’ approval of its re-chartering in 1836, voted it down.
Not surprisingly, the United States then experienced a bout of high inflation followed by a severe recession. There was a movement to create a third central bank for the United States, which was passed by Congress. However, it was vetoed by President John Tyler, who was very sensitive to populist interests in states’ rights in general and, in particular, populist concerns about a central bank.
It wasn’t until 1913 that the concept of a US central bank was successfully brought to life with the establishment of the Federal Reserve. In retrospect, this was nothing short of a miracle given such strong historical opposition to the notion of an American central bank.
Distrust of the ‘elites’
To understand Americans’ opposition to a central bank is to understand America’s rural, populist roots. French diplomat and political scientist Alexis De Tocqueville found that “Americans are obviously preoccupied by one great fear,” which he described as “centralization.”2 This was difficult for him to comprehend; in France, the Bank of France was as French as any other government institution — but that was definitely not the case for central banks in the United States, which were viewed as foreign and un-American.
President Jackson’s opposition to central banks stemmed from his view that they were a tool of “elites,” and that particular criticism has followed the Federal Reserve throughout its existence. Representative Louis McFadden, Chair of the House Committee on Banking and Currency from 1920 to 1931, excoriated the Fed: “This evil institution has impoverished and ruined the people of the United States…through the corrupt practices of the moneyed vultures who control it.”3 Former Congressman Ron Paul actually wrote a book entitled “End the Fed” which, not surprisingly, levels heavy criticisms against the Fed and urges its abolition.
The role of the Fed today
Fast forward nearly 100 years, and we can see that the creation of the Federal Reserve was instrumental in combating the Global Financial Crisis of 2008 (GFC). As former Fed Chair Ben Bernanke explained, “the Federal Reserve took extraordinary steps to provide liquidity and support credit market functioning” through the use of very experimental monetary policy4; this enabled the Fed to pull the US and the world off the precipice of a great depression. The Fed proved its value in stemming the crisis by providing dramatic stimulus and stabilizing markets.
Now the Fed and other central banks find themselves in a very unique position: they have utilized experimental policy tools such as zero interest rate policies (ZIRP) and large-scale asset purchases, which has caused them to drive up the size of their balance sheets and drive down discount rates. For example, the Fed drove its balance sheet up from approximately $800 billion in assets before the GFC to approximately $4.6 trillion in assets.5 The amount has shrunk modestly since then, as central banks have attempted to normalize balance sheets and create some “dry powder” to combat the next recession. However, this monetary policy normalization process has been slow and modest, given that the Fed has competing interests: it has attempted to normalize enough to have tools available to tackle the next recession, without prematurely creating that recession through normalization that is too swift. However, not much normalization has occurred as of yet, suggesting that, if another serious crisis were to occur, other experimental monetary policy tools might need to be invoked.
Several years ago, the experimental monetary policy tool that central bankers and economists were discussing and debating was “helicopter money.” This was originally proposed by economist Milton Friedman back in the 1960s as a way to combat extreme deflation. Helicopter money, at its most basic, is the printing of money by central banks (without taking on any additional debt) to then be spent on government programs or given directly to individuals. Helicopter money was moved from an abstract economic theory to a possible central bank tool when it was discussed during a European Central Bank (ECB) press conference in early 2016; when asked about helicopter money, ECB President Mario Draghi did not dismiss it outright but instead said it was “a very interesting concept.”6
The current politicization of central banks
In recent weeks, discussion and debate has centered on the concept of modern monetary theory (MMT). I think of MMT as being quite similar to helicopter money: at its core, it is the concept that countries can print and borrow in their own currency without concerns about growing debt levels and ensuing defaults, given that they can print money to pay their debts. MMT is being viewed as a panacea that solves current difficult budgetary issues.
Noted economist Kenneth Rogoff describes MMT as being about “using the Fed’s balance sheet as a cash cow to fund expansive new social programs.”7 For example, US Congresswoman Alexandria Ocasio-Cortez invoked MMT when asked how the government would be able to pay for her New Green Deal proposals. And presidential candidate Bernie Sanders, who has made free college for all a part of his platform, relies on Professor Stephanie Kelton, an MMT advocate, as an economic advisor. Ironically, President Donald Trump may have been an early advocate of MMT during the 2016 campaign when he explained in a CNN interview, “People said I want to go and buy debt and default on debt and, I mean, these people are crazy. This is the United States government. First of all, you never have to default because you print the money…”8 Needless to say, many economists worry that MMT will move from an abstract economic theory to a central bank policy tool because of politicians’ involvement.
To me, this is a natural extension of the politicization of central banks in the US since the start of the country. But instead of attacking central banks and advocating for their abolition, some politicians appear to be shifting to a far different stance: appropriating central banks and using them as their tools. However, I must caution that it is central banks’ independence that has enabled them to be successful. In fact, I would argue that the Fed and other central banks were the true heroes of the Global Financial Crisis; that heroism was born of independence.
Central banks are clearly seeing politicization as a threat. Back in December, South African Reserve Bank Governor Lesetja Kganyago voiced concern that threats to central bank independence from politicians were a growing problem, and no longer just an issue in emerging markets. In Brazil, where a populist candidate recently took the helm as president, the new head of its central bank is attempting to carve out greater independence: when he was sworn in last week, he advocated for formal legislation ensuring autonomy for the central bank. And, in a rare TV interview last week, Fed Chair Powell stressed that the Fed is apolitical and will remain that way: “It’s very important that the public understand that we are always going to make decisions based on what we think is right for the American people … We will never, ever take political considerations into effect.”9
I expect that this debate will continue, as politicians see opportunities for greater power and control via the use of central banks, recognizing the awesome power that they have. This could take the form of MMT, helicopter money or any number of experimental monetary policy tools that politicians believe have the potential to be useful. This struggle will only be amplified by rising government debt levels, which leaves politicians with few options in terms of attempting to further their political agendas. It will likely also be amplified by growing populist movements around the world, which might turn their attention to central banks as a bastion of power and elitism. We will want to follow this closely, as eradicating a central bank is not its only existential threat; taking away its independence can be just as harmful.
Events to watch this week
This will be another busy week for markets. Here’s what to watch for:
In short, it seems that it will be another week where central banks will illustrate their power to counteract geopolitical chaos — and remind us why we don’t want to see central banks politicized.
1 Source: “America’s Bank: The Epic Struggle to Create the Federal Reserve” by Roger Lowenstein
2 Source: The Wall Street Journal, “Why Americans Don’t Trust the Fed,” Oct. 16, 2015
3 Source: archive.org
4 Source: Financial Post, “U.S. Fed chairman Ben Bernanke’s speech at Jackson Hole,” Aug. 31, 2012
5 Source: Federal Reserve
6 Source: CNBC, “ECB’s Draghi: We haven’t talked about helicopter money,” April 21, 2016
7 Source: Boston Globe, “Milking the Fed for social-program dollars is a bad idea,” March 11, 2019
8 Source: CNN, May 9, 2016
9 Source: CBS, 60 Minutes, March 10, 2019