Fiscal dominance: how central banks will wipe out your savings

We already wrote about the threat of an outright war on cash, motivated by the central banks’ need to make a zero interest rate policy (ZIRP) effective by forcing money to be held electronically. The topic has slowly started to gain more mainstream media coverage and opposition to ZIRP is building, though sadly it is the fear that the banks will suffer that is prompting the debate, rather than any moral uneasiness about the implied stealth tax on savings. Equally dishearteningly, while negative interest rates are losing support, it is quite predictable what will emerge as the alternative, and it is another policy which has the explicit aim of raiding the wealth of savers.

QE and ZIRP are of course both desperate and dangerous policies on their own, but there is a further paradox in them being pursued together, in that where QE is designed to increase the money available for banks to lend, ZIRP has the opposite effect, being an effective tax on the balance sheet. Somethings got to give, and it is ZIRP which has got the mainstream most worried. Even they can see the inherent madness in a world where you already have several major governments issuing even medium term bonds at rates below zero (both Japanese and German government rates are negative as far out as seven years). Across the “developed” world, central bank rates are already almost at zero or even below, and it is dawning on people that the usual prescription of lowering them by several percent to combat a recession is perhaps not a realistic policy option when inevitably the current mirage of growth fizzles out. But rather than come to their senses and admit that central banks should not be continuing in their futile attempts at manipulating the economy back to health, the pendulum is likely to swing in favour of a policy of much more aggressive QE.

Known as “fiscal dominance”, the policy prescribes that central banks should abandon their monetary goals (control over money supply and inflation) in favour of policies which are specifically designed to prevent the government defaulting on its debt. The “simple” way to do this is massive QE and even outright cancellation of the government bonds bought up by the central bank (for example by converting it to non-interest bearing perpetual debt). That way, governments can stimulate growth by aggressive fiscal policies and finance the whole thing by borrowing – then let the central bank sort things out such that the debt will not have to be repaid. And viola, a money machine has been invented and we can borrow our way out of trouble.

This strategy should be tricky given that central banks are supposed to be independent from their governments, but who really believe that to be the case? The most difficulty is likely to be encountered in the Eurozone, where the Germans and others would be staunchly opposed to policies which debase the common currency and leave the ECB holding worthless debt issued primarily by the most indebted members of the zone.

This opposition would at least be an admission that there is a price to pay, that inflation is not a victimless crime. Indeed, it would not only be the central bank sitting on piles of worthless debt. The inflationary effects of the policy will leave savers everywhere decimated, a massive wealth transfer from savers to borrowers would have been effected. Of course the government will be the major beneficiary, and the policy is simply nothing but a tax on people who have prudently saved for a rainy day, not knowing that when that day comes the government will confiscate their savings by stealth. In the meantime, private borrowers will have piggybacked off the policy to have their debt reduced also, keeping unprofitable businesses alive by subsiding their debt and rewarding frivolous spending. And to add insult to the serious injury sustained by the borrowers who paid for the party, the tax collected will have been wasted on the usual absurdities of fiscal stimulus: unviable investments and vanity projects. Most importantly of course, it won’t work. You can’t save the world by printing money. Fiscal dominance may actually be able to save the government from defaulting in the strictly legalistic sense, but the money they have borrowed still won’t be paid back. The debt bubble will just be moved to the private sector which effectively, though a decimation of private savers, will be forced to take over the government’s debt.

In the surreal world we are inhabiting where central banks are coming up with ever more reality defying schemes to paint over the gaping holes in the economy, it is unfortunately quite likely that fiscal dominance will be tried out before too long. After all, central banks are running out of options but they will never admit it.

Posted April 21, 2016

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