Crunch time for central banks

Since the fundamental imbalances that led to the global financial crisis have not been resolved, debtor developed countries and emerging countries that are dependent on their capital or their demand, are on
the brink of either an increased pace of de-leveraging, with possibly a deflationary depression, or a giant reflation.

Which occurs now depends on central bankers’ willingness to print money and exchange it for a lot of bad bank and sovereign debt. They will have to do so in enormous amounts and go where central banks
have never gone before.

It is difficult to determine what will happen given that this is now about policy decisions and actions, and we should look to see what they do rather than listen to the rhetoric. The actions required for reflation will be obvious because what they need to do is really big, and this is genuinely an issue of choice as no one should question central banks’ abilities to solve the banking and sovereign debt problems. Quite simply, central banks manufacture money. The only problem of debtors is that they don’t have enough of it to service their debts. Desperate debtors and central bankers have a natural symbiotic relationship. If central bankers provide liquidity in exchange for bad collateral and keep doing that, there won’t be a debt problem. However, we will have other problems if this debt monetization is not done in the right amounts and not balanced with the right amounts of debt restructuring.

One issue is that although it is possible to calculate the ways that central banks’ balance sheets need to change in order for central banks to cover commercial banks and the sovereigns, and it’s huge, whilst most of what they are doing will be conveyed in these numbers, we may suspect that even more will be done in hidden ways and we can say that just because that’s always the case in de-leveraging episodes.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla