Central bankers have always been important, but never since World War II have they been more critical than they are now. The bright sparks who invented a second global reserve currency in Europe are now charged with keeping it in one piece; meanwhile, the stewards of the first global reserve currency in the United States are resorting to increasingly unorthodox measures as they find their old arsenal empty in the face of a crisis that they -- and the banks they supervise -- helped create. On Wednesday, six central banks around the world, in a coordinated action, announced they were ready to open their windows wide to any bank which wants to borrow money from them at ultra-cheap rates. It was the latest attempt to get to grips with a series of global crises where central banks have, in general, found themselves very much on the back foot.
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It's not a comfortable place for central bankers to find themselves. U.S. Federal Reserve Chairman Ben Bernanke, recently retired European Central Bank President Jean-Claude Trichet, and People's Bank of China Governor Zhou Xiaochuan aren't politicians: They don't, as a rule, like the limelight. (Bernanke's famous predecessor, Alan Greenspan, was an exception, of course, and he's paying for that now.) In general, central bankers are most happy when they're gathered around a conference table, debating whether to raise short-term interest rates or lower them. Trichet and Zhou are career technocrats, while Bernanke is an academic who once chaired Princeton University's economics department.
Occasionally, however, if an economy gets really bad, as it is now, central bankers are thrown into the limelight as lenders of last resort -- the place to go for a loan when nobody else is willing to lend. For them, it's uncharted, uncomfortable territory.
That, basically, is what has been happening in the most recent downturn. In the United States, the Fed under Bernanke printed money and used that money to buy Treasury bonds. It was an untested and unproven strategy, and it carried substantial risks. "Quantitative easing" (QE), as the practice is known, is prone to distorting financial markets and driving up the price of stocks and bonds without having much, if any, visible effect on the real economy. Indeed, that seems to have happened.
During the first round of QE from 2009 to 2010, the stock market rose more than 50 percent; the second round saw another strong market rally. Both involved investors buying up hundreds of billions of dollars' worth of Treasury bonds, raising their price.
For Milton Friedman's 90th birthday, in 2002, Bernanke gave a speech in which he promised, on behalf of central bankers everywhere, never again to let the world fall into a depression. Those words ring hollow today -- not because Bernanke made bad decisions, but because it turns out that he simply didn't have the ability to prevent another meltdown after all. In the event of a major global financial crisis, it turns out, central banks can only do so much. Right now, their armories are looking decidedly empty in the face of a problem that has never been more daunting. Central banks can cut rates all the way to zero and even buy longer-dated bonds, but the help from that may not come soon enough.
Additionally, Bernanke's huge problems on the rate-setting front pale in comparison with what Trichet and his colleagues at the European Central Bank (ECB) have been being asked to do to save Europe: They have to reinvent the practice of lending money as a last resort.
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