Collusion_How Central Bankers Rigged the World

by Nomi Prins

  Both men were critical of US monetary policy and the risk the US banking system imposed on the world. Carstens, the more politically leveraged of the two, was nominated along with France’s Christine Lagarde for the second-most-powerful central bank post in the world, the head of the IMF. He lost. His US allies did not support him. The decision was one that could have altered the nature of the relationships between the United States and Latin America. Chapter 1 explores the growing rift between Mexico’s US allegiance and independence. The adversarial relationship of President Donald Trump with Mexico affects not just the economies of both countries but also their central bank coordination. Carstens resigned his post as central bank governor after Trump became president, opting for a more international platform as general manager of the BIS instead.

  BRAZIL

  In the wake of the financial crisis, Brazil burst onto the international stage with a determination that it had not exhibited before. The Latin American powerhouse led the charge to adopt an alternative to a financial and monetary system centered around the US dollar. The BRICS10 alliance afforded Brazil sizable financial and political benefits, because China and India were destined to contribute more than 40 percent to global economic expansion through 2020 versus the US contribution of just 10 percent.11

  The story of Brazil in Chapter 2 probes the impact of the Fed’s policy on a country that once had relatively little impact on the international stage from a monetary policy perspective. In the global struggle for supremacy between the United States and China, Brazil emerged as a leading financial and trading battleground.

  CHINA

  To artificially stimulate its markets and banks, the People’s Bank of China (PBOC) adopted a variety of money-conjuring techniques. The Chinese central bank emerged as a primary critic of the Fed, its superpower rival. Raw disdain for the Fed’s policies catapulted China onto the global stage as a currency alternative and economic partner for emerging market nations. In October 2016, the yuan was accepted into the IMF’s SDR basket of currencies, receiving the third-largest weight, behind the dollar and the euro. This represented a seismic shift from the IMF’s former adherence to G7 currencies.

  As the United States exuded an increasingly anti-China attitude publicly, China forged other trade and economic alliances. These were accelerated by China’s reactions to the Trump administration. China’s story in Chapter 3 highlights the evolution of the PBOC and renminbi against the backdrop of ongoing political jockeying between Beijing and Washington.12 It illuminates the reimagining of the existing global monetary system behind this superpower battle.

  JAPAN

  When Haruhiko Kuroda, governor of the Bank of Japan, came to power, he executed the largest conjured-money play in the world. The BOJ’s quantitative and qualitative easing (QQE), which began in 2013, augmented a negative interest rate policy with large-scale purchases of Japanese government bonds (JGBs).

  The real story behind such actions, told in Chapter 4, is one of collusion between Japan’s government and its central bank. As with Mexico and Brazil, balancing the domestic economic situation and US demands created tension. Japan chose to follow the United States from a monetary standpoint but quietly arranged monetary alliances with its neighbor and historical rival, China. In the process, the Bank of Japan amassed a larger ratio of assets to GDP in Japan than any other country in the world. In early 2016, Kuroda led the BOJ into negative interest rate policy (NIRP). From 2013 to 2017, the BOJ expanded its balance sheet from a figure equivalent to 35 percent of Japanese GDP to 94 percent. It bought 80 trillion yen (over $600 billion) of securities monthly to keep rates negative.

  EUROPE

  Finger pointing between central bankers and governments exploded during the financial crisis and its aftermath. The inherent economic stability that resulted ignited a battle between the ECB and the German Bundesbank, the area’s strongest central bank before the euro existed. Wolfgang Schäuble, German finance minister, has been the main critic of the ECB. To curtail market “contagion” in the Eurozone, ECB head Mario Draghi repeatedly invoked quantitative easing with even more creativity and enthusiasm than the Fed.13

  For her part, German chancellor Angela Merkel was politically cautious on Draghi’s policy amid a period of uncertainty about her own political future. Political instability infused with conjured-money policy reshaped EU internal power dynamics. Real growth remained anemic. Youth unemployment reached all-time highs. Greece had to pay for more austerity-linked debt with money it didn’t have. Voters removed or reduced support for old political leaderships. The refugee crisis placed extra political pressure on an already unstable union, pushing voters to the right and ignoring the instability caused by money-conjuring policies.

  Central banks in Europe and the troika—the European Commission (EC), the ECB, and the IMF, and the officials who led them14—exacerbated the instability and growing inequality in Europe. This was a leading cause of the fractured environment that crucified Greece, promoted Brexit, and gave rise to greater potential cracks in the wall of the EU project. It was a sign of a voting pattern traversing Europe, emphasizing the north-west versus south-east divide, invoking nationalism, and weakening the European Union as a whole, as discussed in Chapters 5 and 6.

  What began as a monetary policy commitment to copy the Fed and foster banking liquidity under the guise of promoting growth revealed the disconnect between the money conjurers and ordinary citizens. Citizens were not taking it quietly. They were aware that something was amiss and didn’t know whom to blame besides establishment politicians because they did not realize the extent of the influence of establishment central bankers upon them.

  We have arrived at a new—unstable—normal. There’s no hard stop, no external force or organization to dial back the artificial lubrication of the banking system and financial markets. Yet, “QE infinity” isn’t a solution to real economic growth. It is financial chicanery that can lead to worse problems, ranging from asset bubbles to the inability of pension and life insurance funds to source less risky long-term assets such as government bonds that pay enough interest to meet their liabilities. Low rates hamper savers from reaping adequate interest, which forces them into riskier investments just to grow their nest eggs. Higher rates, however, would constrain the artificially concocted liquidity in the system.

  The issue isn’t whether this money-conjuring game can continue. It is that central banks have no plan B in the event of another crisis. As collusion continues, the Fed continuously reaffirms itself as having succeeded in restoring the economy and stabilizing the banking system. Janet Yellen declared in June 2017 that the dangers of another crisis would hopefully not occur in “our lifetimes.”15

  A decade earlier, her predecessor, Ben Bernanke, got it wrong as well, having declared in May 2007, “We do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system. The vast majority of mortgages, including even subprime mortgages, continue to perform well.”16

  Quantitative easing has resulted in the issuance of trillions of dollars of debt and historically high levels of debt-to-GDP. According to the McKinsey Global Institute, total global debt grew by $57 trillion, and no major economy decreased its debt-to-GDP ratio since 2007.17

  By late 2017, the Fed, ECB, and BOJ held about $14 trillion of this debt on their books. The first decade of the “new normal” began and ended with the hubris of the Federal Reserve’s leadership. It is underscored by global markets and banks that have become dependent on central bank liquidity, too-big-to-fail banks that are bigger than before, and epic debt. Central bankers are “talking up” economies to prove their own effectiveness. This projected illusion of strength is predicated on manufactured money and the masking of structural, systemic flaws. No significant changes have been made in core developed nations to foster real growth and foundational stability. And that means—a more vicious crisis is building.

  1

  MEXICO: There’s No Wall Against US Fi
nancial Crises

  We’re in round one or two. This is a fifteen-round fight.

  —Guillermo Ortiz, governor of the Central Bank of Mexico, World Economic Forum in Davos, Switzerland, January 23, 2008

  In early 2008, Mexico boasted a large and thriving economy. After five years of steady growth, GDP had reached over $1.1 trillion by 2008 from $770.2 billion in 2002.1

  As a gateway to Latin America, Mexico seemed destined to be a US subsidiary, not a partner. So it was doubly ironic when the United States “sneezed,” as it were. The recklessness of the US banking system and insufficient oversight by its key regulator, the Federal Reserve, caused a US financial crisis that temporarily inflicted a “cold” on one of its top three trading partners.

  Having suffered several crises over the previous decades, Mexico had attempted to strengthen its financial stability by crafting a diverse economy that boasted an ambitious population keen on expanding cultural, business, and technological prowess. Mexico was also well positioned with a bounty of natural resources. Both a burden and a curse, the country relied heavily on the United States economically. This would prove to be one of the principal challenges that its central bank, Banco de México, faced when trying to act independently of the Fed.

  Balancing its domestic responsibilities with the demands of the Fed put a strain on Mexico’s historic devotion to US policies. Both of Banco de México’s successively serving governors, Guillermo Ortiz and Agustín Carstens, reacted in different ways to the push from the Fed and pull from their country.

  Ortiz was a man of fortitude, though. He had navigated several Mexican economic crises, including as minister of finance during the 1994 peso crisis. At the time, the New York Times called Ortiz “a bulldog administrator—short on style but tough enough to take on anyone who crosses him.”2 Prior to that, he was chief negotiator for Mexico during NAFTA (North American Free Trade Agreement) discussions and an executive director at the IMF from 1984 to 1988.3

  Ortiz served two consecutive six-year terms at the helm of Banco de México, from January 1998 to December 2009. His father was a soldier during the Mexican Revolution. The military family background affirmed Ortiz’s stalwart personality.4 He led the central bank with a steady hand. He played by the rules of procedure, mixed with lessons of past experiences. That understanding cemented his decisions while giving rise to political tensions when the central bank’s monetary policy clashed with the government’s fiscal one.

  His successor, Carstens, had a slightly more global establishment background and disposition. He was well versed in the ways of the International Monetary Fund and maintained personal friendships with its leadership. Carstens was more Americanized than Ortiz and was an avid Chicago Cubs fan from his graduate years at the Milton Friedman school of economics, otherwise known as the University of Chicago.

  The Fed’s emergency money-conjuring policies stoked domestic power squabbles between the central bank and the government. Growth in Mexico’s international reserves had enabled the central bank to withstand adverse moves in capital markets like the US financial crisis. But the aspirations of the two men varied. Ortiz was a product of the Mexican establishment; he understood its power dynamics and how to navigate its political channels. For his part, Carstens (a confident, corpulent, well-connected multinationalist) believed the central bank was more tied up with the United States than either would have liked.

  HOW IT ALL BEGAN

  On a frosty day in late January 2008, Banco de México5 governor Guillermo Ortiz traveled to Davos, Switzerland, to address the World Economic Forum, a gathering of political-financial glitterati that included prominent politicians, central bankers, and private bankers. The topic was “The Power of Collaborative Innovation.”6 It was an optimistic banner given that financial innovation was about to breed financial crisis. Elite-speak often touts widespread collaboration, but the main power alliances call the shots. This exclusive gathering instigated the divide between emerging market countries and the United States.

  The United States wasn’t in full crisis mode yet. Even though it remained in denial, other nations could not ignore the subprime market and toxic assets built upon this shaky foundation that was about to self-destruct. If they knew, there was no other option but to watch and develop a defensive strategy for the future. This meeting in the Swiss Alps stoked nothing short of an embryonic mutiny against the world’s major power.

  Brazil was the nation chairing the G20 that year. At the Davos proceedings, Henrique Meirelles, head of Brazil’s central bank, presciently announced that leaders should focus on restoring financial stability in the wake of the US subprime crisis.7 Other officials concerned about the US banking system included European Central Bank president Jean-Claude Trichet and Malcolm Knight, chief executive officer at the Bank for International Settlements, the central bank of central banks. Though the looming crisis had not grabbed the public spotlight yet, impending system failure in the United States was already evident to these elites and any journalist paying attention.8

  Nevertheless, everyone paid homage to the US financial system on the surface, even though beneath its veneer of success lay a cesspool of lurking financial dangers. But at one of the panels, Ortiz appeared to have other ideas. He was complimentary in characterizing the United States as “an innovator” in the financial markets. However, he took the opportunity to warn that such innovation was dangerous as well because “almost as a matter of definition, the market outpaces regulation.”

  His panel was hosted by US media personality Maria Bartiromo.9 When asked to comment on credit freezes spanning the global markets, Ortiz quipped, “Well, I can say: ‘This time, it wasn’t us.’”10 Indeed, it was the US Fed failing to do its job properly.

  In Mexico, concerns of an impending crisis were mounting. The United States could afford to act nonchalant. Mexico could not. Ortiz claimed that regulators “didn’t understand” the complexity of various financial instruments.11 He was right. But like other Latin American counterparts who voiced concerns or left rates high when the Fed didn’t, his stance would dampen his career trajectory and was largely disregarded by the major money conjurers. Yet, by breaking away from some of his larger fellow moneymakers, Ortiz sealed not just his professional fate but also in many ways that of Mexico’s economy.

  Conditions in Mexico had already stumbled as a result of the economic recession that brewed in the United States since late 2007. In January 2008, the Hacienda y Crédito Público, Mexico’s Treasury Department, lowered its 2008 forecast to 2.8 percent from 3.7 percent growth in GDP. “That the U.S. downturn will affect us—there can be no doubt,” Mauricio Gonzalez, president of Mexico-based analysis firm Grupo Economistas Asociados, told USA Today.12

  Despite warnings of overheating financial innovation, there was a long-standing partnership between the Mexican central bank and the US Federal Reserve System. Shortly after the leadership gathering at Davos, the Mexican central bank head ascended to a high level of elite status: in February 2008, Ortiz was appointed to the advisory board for the Globalization and Monetary Policy Institute at the Federal Reserve Bank of Dallas, a group studying the impact of globalization on US monetary policy. The Dallas Fed had a tradition of such exchanges with Mexico’s central bank leaders, by virtue of the geography and because Mexican bankers were often connected to US elites. Their alliances ran through academic institutions, American boards of directors, and government relationships.

  Ortiz’s appointment was a culmination of decades of collaboration with his US counterparts. “I have known Guillermo Ortiz for over 30 years,” said John B. Taylor, advisory board chairman and Mary and Robert Raymond Professor of Economics at Stanford University. “He brings unparalleled skills, experience and knowledge about central banking and its global dimensions.”13 Legacy connections proved critical in driving coordinated monetary policy.

  Ortiz’s personal ties with the United States were extensive. He had received his PhD at Stanford University. In 1999, he became a
member of the Group of Thirty, an elite economic and monetary affairs consultancy group comprising the public and private sectors and academia and based in Washington, DC.

  Ortiz sensed the magnitude of shocks to befall the US banking system before US president George W. Bush, Treasury secretary Hank Paulson, or Fed chairman Ben Bernanke did. Bernanke, a so-called expert on Depression-era economics and crashes in America, was readying a massive monetary intervention to eclipse that of the Great Depression of the 1930s. It would signal the birth of major collusive and conjured-money policy across oceans and borders.

  On February 4, 2008, the White House submitted its budget to Congress. Bush proposed a $150 billion stimulus package and the highest military budget since World War II.14 He told Mexico’s president Felipe Calderón that his spending plans would also help Mexico’s economy.15 The United States needed Mexico to stay strong as its own center crumbled. In the age of globalization, stability mattered. What transpired on one side of the border was just as important as that on the other.

  Calderón took his cue from President Bush. On March 3, 2008, he announced a Mex$60 billion (US$5.6 billion16) stimulus package of tax breaks, utility rate discounts, and other spending programs to help Mexico weather the US slowdown.17 He assured businesspeople at the National Palace in Mexico City that his plan would “help make medium-term growth more dynamic.” His words soothed the impresarios seated in the historic locale, where Mexico’s leaders had assembled since the days of the Aztecs.

  As events unfolded, so did financial chaos. It turned out that Bush was preparing for a monsoon with a $5 umbrella. Two weeks later, Bear Stearns, a New York–based investment bank in operation for eighty-five years, collapsed. The bank had leveraged too many complex securities stuffed with subprime mortgages. One CEO in particular who would benefit from Bear’s downfall was Jamie Dimon, a Class A board director at the NY Federal Reserve board.