19 July 2014

Powers of the central bank 2

I wrote in the previous post that one of the fundamental functions of the European federation's central bank should be to have monopoly on issuing  the currency of the European federation which means that the commercial banks should be prevented from creating new money through so called multiplication in the European federation. This measure logically proceeds from what I wrote in the section of basic rights – the economic power must be subordinated to the democratic political power and should be regulated to benefit of all citizens of the European federation. But it is not sufficient to entrust the central bank as a public institution with monopoly on issuing money; it is also necessary to bind the central bank by some rules in order that its activity can be democratically supervised.

The main question associated with issuing money is a question of their amount in circulation or in other words of inflation. The present central banks mostly have price stability as their principal objective. That should mean zero inflation but central banks pursue more or less 2% inflation policy which however in strict sense of the words is not price stability but growth of prices though very low and only little differing from price stability.

A question of zero inflation is dependent on what function we expect from money. The fundamental definition of money is that money is a good purpose of which is to determine value of all other goods. But if it is necessary constantly to spend more money, though not radically, for the same amount of goods it meets its purpose not well. At a given moment of time or in short periods, depreciation of money is not obvious but it is obvious in longer periods of time that greater amount of money has to be spent for the same changeless goods in the moderner time than earlier. One piece of information can show how inflation degrades role of money as an indicator of value in long-term range: in Germany in period 1950-2000, GDP rose approximately seven times but amount of money supply rose 32 times. Then a question should be asked what amount of money in circulation represents if it so diverges from amount of produced goods and services. This disconnection pronounces in favour of zero inflation as well as another purpose of money: it holds value. It is unnecessary to justify why inflation is harmful in this case.

In search why small rate of inflation is advantageous one encounters an argument sooner or later that issuing new money cannot be limited too much because economy needs continual inflow of money and central banks consider inflation slightly under 2% to be an indication of sufficient amount of money in economy. Economist who are at the helm (so in central banks too) are convinced that easy availability of money for firms is a paramount and almost only condition for well working economy. Unfortunately they do not realize that economy will not work only due to abundant money. In the present time, many central banks pursue policy of so called quantitative easing which is in fact pouring money in economy with the hope that firms will so have enough money to grow; but this presumption proves not true. European Central Bank provides commercial banks with cheap money yet they grant loans to firms only unwillingly and use the money rather in so called financial casino where profits are higher than in real economy. In the year 2007 allegedly only 1,7% of worldwide money was used for real economy transactions, the residual 98,8% were used for various forms of financial speculations. Simply, the commercial banks are convinced that their investments in firms in real economy (through loans) are not able to secure sufficient profit to them – action of commercial banks is logical from their point of view. Let us assume that firms really get - in the form of loans - money that central banks so generously pour through quantitative easing in economy. Firms would use it probably to their “expansion” or in other words to expansion of their production. But then the cardinal question is: who would consume such increased production if incomes of middle and lower classes fall in the long term, already decades? Perhaps great firms and the most wealthy individuals incomes of which precipitously grow on the contrary? Such question is probably not asked by economists. The real problem of present (European) economy is not at all lack of credits but undue and constantly increasing unevenness of what has been produced in economy. If economy is set to primarily secure increase of profits for the greatest firms (and the wealthiest individuals) even however big flood of cheap and available credits will not create healthy economy fulfilling needs of people. Economy should first of all be taken as sum of activities to secure needs of people, instead of it, it is taken by economists and politicians rather as a machine for securing prosperity of firms (and their owners) and when stock values growth in the stock markets it is regarded as a evidence of growing economy (“recovery”) even if living condition of most population worsened (the equation “prosperity of firms = prosperity of people” is not valid more in the world of today). In addition of that, the mainstream economists and most politicians still propagate necessity of constant growth although it cannot be a basis of wealthy economy and although the growth cannot last forever (inability to change this self-destructive course is one of the greatest defects of present capitalism and its financial system). Generally, it can be said that classical theorems about relation between quantity of money and wealth of economy (from the point of view of its ability to fulfill needs of people) fail today. Because policy of providing commercial banks with multitude of money does not satisfy the role of securing needs of people through economy I do not see also now a reason why the central bank of the European federation should not pursue the objective of zero inflation policy.

Apart from the mentioned function to exclusively issue the currency of the federation and to preserve zero inflation, the central bank of the European federation has to have other more functions that more or less correspond to that ones of the present central banks. I mention supervision over the financial market in the first place, in other words supervision over banks, insurance companies, stock markets, credit companies and other financial institutions. Rules regulating formation and functioning of these institutions has to be determined by the law, the central bank however should oversee discharging the law in order that only the institutions (firms) can operate in the financial market that meets the conditions prescribed by the law.

Another function is associated with the previous one, administration of money circulation and of system of payment which above all includes handling physical currency and organizing bank-to-bank payments. The role of the central bank should be that money flow is smooth as well as secure and economical.

The supervisory and controlling function of the central bank of the European federation should on at least one ground be broader by one item. If the central bank should obtain money issue monopoly in all its forms the commercial banks will be forced to get additional money for their business by purchasing them at the central bank instead of their (almost) effortless creation in their computers. It can be expected that commercial banks might try to get around this necessity by creation of various derived bank products and so creation of new money by them would continue as today. The central bank of the European federation must therefore have the possibility to safeguard its money issue monopoly by supervision over bank products created by commercial banks including supervision over treating the fundamental financial instruments like investment accounts that could be used to get around issue monopoly of the central bank first of all. This power of the central bank is however important also on another ground. An ideology of the market bound by nothing rules in the present time, every “player” in it has the right to achieve the profit in almost whatever way, especially without regard to societal consequences. The banks and other financial institutions take advantage of it in a large extent and create various exotic bank products that usually comprehends almost nobody and although these products are called modernization of the financial system they serve often only to immoral enrichment, for example to the sale of inferior credits and the like. Therefore it is desirable that the central bank has the competence to determine rules according to which individual categories of financial products should be traded in. It is true that such matter should be regulated by the law but beside that also the central bank should have the same competence in cases not envisaged by the law to be able to promptly react to development in the financial sphere. Of course, it is obvious that all supporters of the “free market” or in other words as least as possible or preferably no regulations would energetically denounce this provision but it is in accord with the already here discussed provision about basic rights saying that the economic power should be subordinated to the democratic political power. And if it is obvious that some economic activity is harmful to the society it has to be regulated or even fully made impossible without regard that it allows to ineffably get rich to some small minority and it therefore wishes its preservation.

The last function of the central bank of the European federation mentioned by me here is to be the bank of the Union, in other words to conduct accounts of the constitutional and other institutions of the European Union. The reason is that it should be more advantageous for the Union and it is also a question of transparency of managing public financial resources because to place finances necessary for functioning of the Union's institutions in account of commercial banks would arouse suspicions about interconnection of the said banks and politicians who decided about that placement. The principle is also important that a public, not private institution handles public resources.

In the end, I make remark about a way of issuing new money and its putting into circulation by no more than few words. A demand could arise that the currency of the European federation is backed by some material good as it was so by precious metals earlier. The present currencies are backed by nothing except by trust of their users that they can buy something for it. The same was actually true in the past too, the trust was given by contents of the precious metal. Today, the precious metal in the role of trust giver was replaced with the policy of the central bank. Dependence on the precious metal was however disadvantageous in the past because new money could not be put into circulation in the case of precious metals lack though economy needed more money. So I believe that the currency of the European federation should not be backed by some material good, that everything should stay unchanged in this respect and that no respective provision is necessary in the federal constitution.

The central bank puts new money into circulation through the commercial banks. It actually sells (lends) the money to them in various ways (“free market transactions”). The central bank is dependent on the commercial banks in this respect because the commercial banks are not willing to acquire money from it under any conditions. If the commercial banks are not willing to take money from the central bank under the current conditions the central bank must cut interest rates for which it grants new money to the commercial banks in order that they are more willing to borrow new money and so to put it into circulation. Many central banks (including ECB) conduct this policy of cheap money now but the commercial banks do not release money obtained this way into circulation. So even although the commercial banks have the right to extensively multiply money obtained from the central bank the central bank can in certain circumstances have a problem to up amount of money in circulation. I believe therefore that the central bank of the European federation should have a possibility to put new money into circulation also in other way than through commercial banks though it should not necessary use it often. The most logic answer to such necessity is to provide the Union (or the member states) with a required amount of money because it will put it into circulation absolutely certainly and will not retain it or play them in financial casino (speculations) unlike the commercial banks.

These were the most important powers of the central bank of the European federation that should be enumerated in the European constitution's text, it is sufficient that other less important competencies will be treated in a separate specialized law.