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Central Banks Fight For Survival

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Now more than ever, market needs deflation.

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When I hear the words "central banker," I don't picture a bald-headed academic, patiently explaining the tedious minutiae of monetary policy to thick-skulled, loud-mouthed politicians on Capitol Hill.

Instead, I think of a lumberjack, tenuously perched on the tip of a log floating in a river, desperately trying to out-balance his foe.

Log-rolling, a sport invented by lumberjacks driving lumber downriver to sawmills, pits 2 competitors standing atop a log as it floats along the surface. Mirroring the other's moves, each participant's goal is to spin the other off the log into the water.

The Federal Reserve, and indeed central banks around the world, are pitted in a battle not unreminiscent of those dueling lumberjacks. Their adversary, however, is nothing so unintimidating as a single wood-chopper - they face an unwieldy, inconceivably complex national economy. Imagine herding cats - Tyrannosaurus-sized cats roaming around in packs of thousands.

Nevertheless, scores of economists, pundits and private citizens entrust their economic well-being to these monetary masters, however poor their record may be.

A piece in this morning's Wall Street Journal entitled "Central Banks Are Creatures of Financial Crises" chronicles the history of central banks, asserting that they owe their existence to society's excesses. Asset bubbles beget dramatic financial crises, and benevolent central banks have been forced throughout history to protect the many from the bad actions of the irresponsible few.

Ultimately, however, central banks have a destabilizing effect on markets, encouraging reckless risk-taking and manipulating interest rates for the benefit of those same privileged few.

Initially established in 1913 to be a "lender of last resort," the Federal Reserve has seen its power and influence grow. The establishment would have us believe that the Fed carefully maintains a prudent balance between inflation and growth, which we're told creates greater prosperity for all.

What we're left to figure out on our own, however, is this: As central banks hold interest rates artificially low under the pretext of maintaining strong economic growth, paper money is devalued, and the wealth we do manage to accumulate gradually erodes in value. This is fine - so long as we don't accumulate any wealth. Hence the perpetual belief that spending in vast quantities is our patriotic duty, though we support the national economy to our own detriment.

Issuing mountainous debt -- as the Federal Reserve is currently doing to "rescue" the financial system -- cheapens the value of the very dollars we now so desperately covet. Likewise, as the Treasury doles out guarantees and loans to the likes of Citigroup (C), Bank of America (BAC), Fannie Mae (FNM), Freddie Mac (FRE), AIG (AIG), General Motors (GM) and Chrysler, a host of non-elected officials were somehow given the power to take money out of the wallets of average Americans.

Main Street is now working harder for fewer dollars, and each one of those dollars is worth less than it was yesterday thanks to around the whirring sounds of central bank printing presses being run around the clock. As former presidential candidate Ron Paul is apt to ask "Is there any moral justification for deliberately devaluing the currency?"

Paul's is not a new concern, that government issuance of massive debt isn't any way to run a country. Thomas Jefferson wrote in 1816, "To preserve our independence, we must not let our rulers load us with perpetual debt. If we run into such debt... [we will] have no time to think, no means of calling our miss-managers to account but be glad to obtain subsistence by hiring ourselves to rivet their chains on the necks of our fellow-sufferers."

Even now, however, central banks are facing what could be their greatest test. The market, which they're perennially battling, is screaming for deflation. Assets of all types, long the beneficiary of loose monetary policy, are falling in value as Americans shun debt and hoard dollars to repay loans.

At stake is not just the economic well-being of a country, or even Main Street Americans. Central banks are fighting for their own survival.
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