LONDON — This is a tale of two banks, combined with a large dose of blind faith and credulity.
The two banks are the Bank of Japan and the Federal Reserve of the United States. The blind faith is the very widespread belief that these two institutions, by juggling with short-term interest rates, or through similar devices, can miraculously reverse the forces that are dragging down world stock markets and sending shudders through the global financial community.
The question is how confidence is to be restored. How can we re-create the mysterious “essence” that makes consumers wake up in the morning and want to go and buy things, and businessmen wake up in the morning and want to go out and start new projects, commission new factories, open new offices and shops, or just purchase a new computer or set of office furniture?
Along come the witch doctors with the answer. If the central banks will only announce further really big reductions in the official short-term cost of money, the overnight minimum rate of interest, then miraculously the world will start to feel happy again and everything that has gone down will go up.
Of course it is all mumbo-jumbo. The power and influence of central banks to change the direction of moods and events world-wide is vastly exaggerated. But it is mumbo-jumbo that is very widely believed, especially in financial circles and especially among economists.
It is a small world, in which stock markets look to central banks and bond markets look to central banks, and the central bankers look at the markets and all three look at each other.
It used also to be quite a closed world, in which the gyrations of stock values and sentiment in financial circles could be relatively insulated from general business activity and daily life for most of the world’s citizens.
But this is no longer the case. In a globalized system volatility is hugely amplified. Crowd psychology prevails. Forty-nine percent of households in the U.S. are said to own shares directly and there is no doubt that their exuberance, having already been severely battered by the collapse of the “bubble” in the shares of dot-com companies, is being further hit by the general decline worldwide in stock markets. (The figures are much lower in both Europe and Japan, but still substantially greater than they were 20 years ago).
So all these people become easy prey for the economic “experts” and miracle-cure workers and join in the general belief that their riches can be restored by central-bank magic.
The snag to this is that confidence and economic behavior no longer respond in the ways economic theory proclaims and that the “powerful tools” to change things, as for example the economist Paul Krugman describes them, do not really exist. No one really knows what the supply of money is, or whether fiddling with official interest rates will alter it. Or even if they did, no one can be sure about the effects this will have either on panic-inclined investors or on the wider inclinations of consumers and investors, which may derive from matters far outside the range of economic analysis and be more related to history and political philosophy than to economics.
In the present situation the moods in all three main areas of the advanced world — the U.S., Europe and Japan — can all be traced back to deeper, and differing factors that economists, sadly as usual, tend to overlook.
In the U.S. we are seeing a straightforward pause for breath. The boom conditions of the last few years were bound to end. Just as all human beings need a rest, so do societies of which human beings are composed. The first frenzied excitement of the information-technology revolution is over, although it is indeed a revolution and its effects on work, life and society are only just beginning.
In Europe, the downturn, especially in Germany, is the opposite of what many economists predicted. This is because they believed all the hype about the euro currency as the rival to the dollar, which would transform enterprise throughout the continent and create new levels of prosperity. Actually, enterprise and wealth creation flourish when government is light and stable, laws are just and taxes low. Currency juggling and attempts at “economic management” make little difference, except to unsettle things.
The Germans feel thoroughly unsettled by losing their proud and strong mark, by over-taxation, by the failure of the former East Germany to rouse itself and by the new dynamism of its eastern neighbors, such as Poland. Ironically, it is these former communist states that have learned the secrets of modern economic confidence and growth fastest and which may well increasingly overshadow over-regulated, arthritic Western Europe in the new century.
In Japan, the problems are different again and are probably most to do with political leadership, or so it seems from outside. Much nonsense is talked about the need for the Bank of Japan to print money and create inflation. But if this could be done, which it probably cannot, the outcome would do more harm than good and, anyway, that is not where the problem lies.
In all three continents, deep, complex although differing political influences are operating that will have to work themselves out. Central banks can play only a marginal part in changing the direction of events. The longer people are led to believe by economists that, on the contrary, they can miraculously alter everything by just pressing a few buttons, the greater and more prolonged will be the disappointment when it is found that they cannot.
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