[Akira Ueyama's Quotes 6] Central Banks as Game Makers
Now, let me briefly talk about how central banks have moved throughout history.
A. The Birth of Central Banks
It began with the religious revolution. Protestantism emerged from a Catholic-dominated Europe. While Catholicism was not tolerant of Jews, Protestantism accepted them. Then, Protestantism spread among the intellectual class. Since people could read and study the Bible for themselves, they no longer needed to go to church, which made it popular among intellectuals. In this way, connections were formed between knowledgeable people and Jews, and the financial system was born.
The first stage for this was the Netherlands. They built a central banking system and created a market to raise funds. After that, the Netherlands established many trading companies and became a major trading power with significant influence.
Next came England. Before the Glorious Revolution of 1688, England was struggling with religious issues. However, the revolution ousted the Catholic king and welcomed the Dutch King William of Orange to the throne. At that time, the Dutch Jewish network also moved into England, and England was able to establish a central bank. That was the Bank of England.
This Bank of England played a huge role in England's growth in the 19th century. It was an era of war, and vast amounts of funds were needed. England didn't just make money through trade; it raised funds by selling bonds through the Bank of England. That's why it was strong even in wars against France.
Then, England received reparations from France after the Battle of Waterloo and started the gold standard. With the Bank of England at the center, England's financial system was firmly established. Although America also grew economically in the 19th century, its fundraising was almost entirely centered in London.
The Bank of England adjusted interest rates to create business cycles. Because of this, booms and busts were repeated for about 80 years starting from 1820. For American investors, the movements of the Bank of England were extremely important in observing the economy.
B. The Founding of the FRB
The role of central banks was significant. For example, the success of the sterling pound system was because the central bank played its role firmly during financial crises. It was precisely because a central bank existed that England was able to build its status as a hegemonic power at the time.
On the other hand, the story of America is different and quite interesting. In America, there were two groups from the beginning—the 'Federalist' group and the 'Anti-Federalist' group—and they were constantly clashing. A man named Hamilton said, 'Financial policy should be unified across the entire country,' while a man named Jefferson countered, 'No, no, each state should have its own authority.'
Actually, America also tried to create a central bank, but it didn't go well, and in the end, they only had a central bank for about 40 years. Most Americans thought, 'We don't need a central bank.' This idea was incredibly deep-rooted.
In the midst of this, America was also swept up in economic waves due to the policies of England's Bank of England. At that time, the entity that became the financial coordinator in America was the Morgan banking group, and they held more influence than politicians. Eventually, with the help of the Morgan group, a central banking system was created in America as well. That was the birth of the FRB in 1913.
However, interestingly, Americans did not call this new bank a 'central bank.' The reason is that the name didn't really sit well with Americans. So, they gave it the somewhat confusing name of 'Federal Reserve Bank.' In fact, it was created by bringing together 12 regional banks, which is why it got that name, but each regional bank holds a role like a central bank. This mechanism still continues today.
People in America have been wary of central banks for a long time.
In the 1910s, when communism was rapidly gaining attention, Lenin said, 'The final stage of capitalism is financial capitalism.' Many people agreed with this, and distrust of financial institutions increased. Perhaps there was a headwind blowing against the American financial industry at that time.
C. The Bloating and Independence of Central Banks
When the power of the federal government increases due to war, the power of the central bank also tends to increase. The FRB was created in 1913, and the First World War happened to start the following year. During this war, the FRB played a major role in fundraising and was also deeply involved in the post-war reconstruction of Europe. The Morgan group was also moving behind the scenes. Through the First World War, the influence of the Morgan group and the FRB increased overwhelmingly.
The role of the central bank was small at first, but it gradually increased. In particular, its role as a 'lender of last resort' during wars and recessions was significant.
But what's interesting is that the federal government is not a major shareholder of the FRB. Private financial institutions like Goldman Sachs and Lehman Brothers are the main shareholders. From this, the independence of the central bank strengthened, and it began to reject political intervention.
Politicians want to improve the economy for the sake of elections. However, if that goes too far, inflation occurs. Against the backdrop of the inflation problems of the 1970s and 1980s, the independence of central banks was emphasized. As globalization progressed in the 1980s and 1990s, central banks clearly adopted a stance of being independent from politics.
Japan also revised the Bank of Japan Act in 1998, making the Bank of Japan independent from the government. Such movements were seen all over the world, and rules were created to keep political pressure away from central banks.
D. Roles and Challenges of Central Banks
The role of central banks influences not only the stock market but actually the much larger bond market. Interest rates are super important in the bond market, and it is the central bank that adjusts those interest rates. Central banks use this interest rate adjustment to keep the entire economy running smoothly.
Central banks have a role as game makers. Their role has become particularly significant since the 1970s. Before that, the market was fixed by a fixed exchange rate system, and interest rates were strictly managed. However, entering the 1970s, with the oil shock and the Nixon shock as triggers, the floating exchange rate system became mainstream, and market movements changed significantly. This led to more attention being paid to the trends of central banks.
And it was Paul Volcker who showed the power of central banks in the 1970s. He raised interest rates significantly to curb inflation. Of course, this caused various economic problems, but the economy stabilized afterward. From this point on, it became clearer that the movements of central banks create economic cycles. Paul Volcker's successor, Greenspan, even came to be called a 'Maestro' (master conductor).
Until around the 1970s, cycles of inventory and capital investment indicated economic movements, but that changed in the 1990s. As the Toyota-style manufacturing method of not holding inventory became the global mainstream, companies stopped holding inventory, and the method of grasping economic trends based on inventory could no longer be used. When that happens, it becomes difficult to understand what is causing booms and busts, and complex adjustments by central banks have become more important.
In short, the movements and roles of central banks are super important things that sway the entire economy. If you understand that, you can think about future economic movements and the challenges of central banks.
The Lehman Shock occurred when the influence of central banks was increasing. This Lehman Shock is an extremely important event when considering the challenges of central banks. Why did Lehman Brothers and Bear Stearns collapse? It involves investment banks. Actually, central banks only supervised commercial banks, and investment banks were outside of supervision at that time. This is what is called 'shadow banking'.
Central banks could not grasp how much risk investment banks were taking in their business, and in that situation, Goldman Sachs and Lehman Brothers had leverage (borrowed money) of more than 30 times their equity capital. Experts who realized this was bad created the Dodd-Frank Act in 2010, which restricted such high-risk behavior. As a result, investment banks that were previously shadow banking-like became properly monitored.
However, hedge funds, private equity, and pension funds are still operating while escaping the eyes of the Fed. Since these funds are for professional investors, there is almost no need to disclose information.
International organizations are also requesting information disclosure regarding shadow banking, but progress is slow. Because shadow banking has money and influence, they are lobbying properly so that they do not have to disclose information.
In the future, a financial crisis might occur again from shadow banking. Central banks should play a role in making the movement of money transparent. This can be said to be an important job for central banks now.
Shadow banking, this is the keyword of the modern era. Not only in the United States, but also in China and Russia, every country is facing this problem. For example, looking back at Japan's bubble era, housing loan companies were supplying funds to the real estate market as financial institutions. That was also a part of shadow banking. Furthermore, Japan's consumer finance also falls into that category.
Actually, no matter which country you look at, the existence of shadow banking is noticeable. It is not that everything is bad, but large players such as hedge funds, private equity, and pension funds are exerting a major influence on the market with their leverage. We are in a time when we must be aware of the risk that a crisis like the Lehman Shock might happen again. The World Bank, the IMF, and various central banks are issuing warnings, but regulations have not been made yet.
What is even more concerning is that China, Russia, and other countries have doubts about the Western capitalist system, especially shadow banking. Originally, they feared that the dollar, which is the settlement currency, would be used as a weapon of financial sanctions, and they are trying to build an alternative system. This is a movement seen as part of a 'Global Reset'.
The key is how central banks in developed countries control and make shadow banking transparent, and if this cannot be done, movements aimed at independence from the dollar-centered financial system, so-called 'De-Dollarization', centered on China and BRICS countries, may accelerate.
How central banks will establish their position regarding future challenges is what is being questioned.
Summary
・Against the backdrop of the religious revolution, the connection between Jews and the intellectual class deepened, and the world's first central bank was established in the Netherlands. Later, the UK also established a central bank, which played a central role in the British economy in the 19th century.・In the United States, where there is an aversion to the expansion of the central government, a central bank was not easily created, and the Fed was finally born in 1913.・During wartime, the power of central banks increased. After World War I, the influence of the Morgan financial group and the Fed increased. Also, because there were many private financial institutions as major shareholders of the Fed, the political independence of the central bank became guaranteed.・Central banks influence the movements of the entire economy through interest rate adjustments, and their role has increased. In the 1970s, the role of central banks increased with the shift from a fixed exchange rate system to a floating exchange rate system, and Paul Volcker raised interest rates to lead to economic stability. In the 1990s, as globalization progressed, the adjustment role of central banks became more important.・The Lehman Shock highlighted the issue of 'shadow banking', and although risk management for investment banks was strengthened by the 2010 Dodd-Frank Act, monitoring of other financial institutions is lagging. With movements seen where China and BRICS seek independence from dollar-centered finance, the future response of central banks is the focus.