Friday, October 5, 2012

Why Central Bankers Prefer a Long Depression (Article 2011)

“The problem of leverage, the sheer volume of debt in the economy, is still very large and this poses massive macro-economic challenges. I think these macro-economic challenges will last many years.”

So says Bank of England Governor, Mervyn King.

Meanwhile, in Happyville, Eric Johnston informs readers of The Age:

“Westpac has delivered a seven per cent increase in first-half cash profit to $3.17 billion as charges for bad debts fell away sharply in a further sign the worst of the financial crisis is behind the banking sector.”

He’s right. It is behind the banking sector. Close behind. And catching up fast. We have an urge to say “Behind you”, pantomime style!

It’s not often we agree with central bankers. But on this occasion we’ll agree with Mr. King.

Of course, you need to take his comments in context. Because he also said:

“The economic consequences of high-level indebtedness now would become more severe if rates were to rise.”

Which is why he voted to keep the Bank of England interest rate at a record low of 0.5%.

It’s the economic equivalent of refusing to step on the brakes as your car is travelling at 200km/h towards a brick wall, because you’re afraid of wearing out the brake pads!

The truth is, touching the brakes may not stop the economy hitting the wall, but it’ll certainly slow the car down.

But what Mr. King’s comment reveals is central bankers have played the odds. They figure it’s more important to have a long economic depression that “will last many years” rather than allow a sharp and temporarily damaging bust.

Why would they take that view?

Take the pain now

Simple: a short and sharp bust is damaging in the short term to individuals and corporations – including banks. But in the long term, it’s positive for individuals and most corporations – excluding banks. Read More