Central Banks: Moneylenders, Santa Clauses or Vampires?

By Hak Choi (Former) Advisor, Chung-Hua Institution for Economic Research. Correspondence: hakchoi@gmail.com Abstract This paper proves that central banks are not moneylenders, they are perhaps Santa Clauses, but in reality they are vampires sucking our blood. The bigger they grow, the hungrier they are. (JEL: E41, E58) Keywords: Central Banks, Vampires, Slavery

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I. Moneylenders? No They say money is powerful, for it eliminates the double coincidence of wants. They even say the more money the better, and they print like manias. If there are people or companies dying, central banks, like supermen or Santa Clauses, arrive with bags of money. If the action proves too slow or selective, some suggest using helicopters to sprinkle the money. They may attach string of austerity condition, but eventually they always give in and give away the money. Central banks are the best moneylenders, lenders of last resort, so they say. The image that central banks are moneylenders is coined by Keynes. According to him, there is a demand for money and a supply of money, as depicted in Figure 1. The demand is derived from households and business consideration, while the supply job is performed by central banks. However, such picture, like money itself, is illusionary. Consider first the negative demand function. According to Keynes (1936, Ch. 15), when interest rate is low, bond price is high, people will sell bonds and possess more liquidity, which means money. This phenomenon is called the speculative demand, which is the major component of the demand for money. However, such relation can as well be positive. Ceteris paribus, an increase in cash holding, as a result of a decrease in interest rate, should lead to a drop of bank deposit by the same amount. Through the deposit multiplier, there should be an even larger drop in money supply. Hence, the speculative demand must be a positive function of interest rate. This is the first pitfall of the Keynesian reasoning. Suppose the increase of cash holding is entirely financed by new money, the negative effect on the money supply is neutralized. There is no change of money supply, except by exactly the same amount of the new money. It looks as if there were a

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negative relation between interest rate and money, but this is not a meaningful relation, for other things were not held constant. One cannot claim a relation between two variables by changing a third one. It violates ceteris paribus. This is the second pitfall. Thirdly, the investment strategy Keynes employed is a posthumous operation: if the price is high I sell. Had I only known the price is sure to rise! There is only one way to know it for sure: to place the order after the market is already closed. But, such operation is illegal. Hence, there is no demand for money, in a negative relation with interest rate. After all, using money to buy money is tautological enough. The perpendicular line standing for money supply is also non-economics. Such line represents fixed supply, but printing money does not have any limit. Hence, Figure 1 is simply illusionary.

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Figure 1. The Keynesian Money Theory

When there is no money market as per Keynesian setting, central banks lose their premises for conducting the money lending business. They are just not moneylenders. Is there any central bank, which is so candid? The European Central Bank, for one, "has made it clear that it does not want to pursue its role of lender of last resort" (Grauwe 2011, 11). But, does it keep its promise?

II. Santa Clauses? Maybe Below is the confession of a central banker. Alas, I know I am not a moneylender, I know I should not print money emptyhanded, but there are people desperately in need of it. Never mind economics, I just print money and save some shipwrecked souls, starting from my own government. I print money to buy government bonds. I earn interest and claim that government owes me debt. If my government will be unable to redeem the bonds upon expiry, I will print more money and buy more bonds. Indeed, the more the better. To avoid being caught for usurping other people's money for profit, I kick back some of the profit to my government. Eventually, the general public have to pay more tax for the interest and for the debt, but they may never know my tricks (I hope).

III. Vampires? Yes Further confession. Suddenly I find myself becoming a bigger central banker, that of ECB, thank to Mundell (1961). I still know that I am not a moneylender, and that I should not print money empty-handed, but there are "pressures" and "requests" that force me to do so, first from Portugal, then Italy, Ireland, Greece, Spain, and now from Cyprus (PIGSC). Alright, I help them. I buy their bonds, and they also happily pay me

interest. This time, I don't have to allot the profit to these governments; I still kick it back to the bigger ones. They look stupid, my colleagues the smaller central bankers, to have given up such lucrative business! The PIGSC are very obedient too. When I ask them to come to Brussels, they waste no time. When I lecture, they listen. I tell them that they have been prodigal, and now they have to work more and spend less. And, that a great part of their income has to pay me as interest due. End of the confession.

IV. Dreaming for Moses PIGSC: " We are locked in the debt bondage. We have become slaves, prey of the vampires. Wasn't the old time better, when we could at least keep our own interest payment? Should we stay put and continue to be exploited? Is there a Moses who will lead us out of this bondage?"

V. An Exodus I, the present author, have communicated with some PIGSC economists, and have urged them to join me to advocate breaking away from the Euro system, but most are afraid that their economies are too fragile to such shock therapy. The new money "will become in a matter of days if not hours, a valueless, non-tradable currency," one said. I disagree with this pessimistic view. Below is the dialogue I held with my friend, Hu, representing PIGSC.

I: "If I can help you get back your seigniorage, to whom would you turn it?" Hu: "To my central bank."

I: "If you turn it to any third party, does it make any difference from turning it to Germany?" Hu: "You mean my central bank is also a third party?" I: "Yes." Hu: "To whom should I hand it, then?" I: "To yourself. You print your own money." Hu: "Can you be more specific? How can I print money?" I: "Your treasury does." Hu: "What is the advantage of printing money myself?" I: "You don't have to pay interest, you don't bear national debt!" Hu: "Wow! I feel so lightened." I: "Congratulation! Now you understand my points." Hu: "Would my treasury overprint?" I: "It would, but at least it would not turn around and ask you to pay interest and repay the debt." Hu: "Is there a way to prevent the treasury from printing too much?" I: "You mean: Is there a way to prevent Berlusconi from squandering too much?" Hu: "Yes." I: "The way you control your son or your wife from splurging too much." Hu: "That way the new money would not become worthless paper." I: "You get the point!" Hu: "But I don't have gold. How can I print money without the backup?" I: "If your people live happily and earn enough profit, you will have gold from their deposit. You will be the custodian of the gold, upon which you print money."

Hu: "How about the debt I owe to the ECB?" I: "Sue the ECB, and ask it to write off the debt. Here is the reason: Originally, you owed your own central bank, but the money you borrowed actually was your own money. When your central bank transferred the debt to the ECB, it is still your own money." Hu: "Wow! That is great. I don't have internal debt, and I don't have external debt." I: "Will you dare to borrow any more?" Hu: "No."

References GRAUWE, P. D. (2011): "The European Central Bank: Lender of Last Resort in the Government Bond Markets?," CESifo Working Papers, 3569. KEYNES, J. M. (1936): The General Theory of Employment, Interest, and Money. London: Harcourt Brace. MUNDELL, R. A. (1961): "A Theory of Optimum Currency Areas," American Economic Review, 657-665.