Central banks prevented serious financial crisis, speaker says

Philip Turner, head of Secretariat Group in the Monetary and Economic Department of the Bank for International Settlements, spoke about the notion of “international money” and the impact of the ongoing financial crisis in redefining the term in his “Conversations with Economists” lecture at the College of Arts and Sciences on Monday.

“First, we have to understand that there is no such thing as ‘international money,’” Turner said to an audience of more than 50 Boston University students and faculty members.

During the financial crisis, the U.S. dollar remained the key official money, but bank credit also served as “private money” and gave bankers more flexibility with deposits, Turner said. As a result, private money and liquidity evaporate in a crisis.

“But there is also a ‘private money’ that comes from bank credit creation,” Turner said. “Banks and other institutions can innovate and create private liquidity. They can make the money that depositors place with them go further by leverage and by taking risks. And this is exactly what led to the crisis.”

The markets of debt-based derivative products were huge and appeared to be very liquid, Turner said. While private money appeared to respond to the continuous demand of highly geared financial institutions, he said that the so-called liquidity was just an illusion.

“The triple-A status of these products was also an illusion,” Turner said. “Nobody could trust even the largest of the banks. Private liquidity just evaporated.”

Turner said that the central bank creates for the private sector any amount of money it needs. In advanced countries, the central bank takes domestic assets, whereas in emerging market economies it takes foreign assets.

“After Lehman Brothers in 2008, the balance sheet expansion has been extraordinary in size, type and persistence,” he said. “The hope grew during 2009 that this extraordinary expansion in central bank balance sheets could soon be reversed.

“But the Greek crisis in May 2010 dashed these hopes. It is now clear that central bank balance sheets will remain packed with long-term assets for many years.”

Central banks in other advanced economies expanded their balance sheets to an extraordinary degree, similar to the expansion of the Federal Reserve’s balance sheets, Turner said.

“European banks have a particularly big problem,” Turner added. “Their international lending is largely in dollars but most of them do not take retail deposits in dollars, so they end up going to wholesale markets to borrow the dollars.

Now investors fearfully avoid risk and illiquid assets, Turner said, causing the banks to compensate.

“The growth of their balance sheets seems startling, and in some ways it is, but it is quite normal for official money to take over when private liquidity collapses.”

“Central banks have averted debt deflation, keeping debtors afloat and reducing default risks facing creditors, avoiding a blunder like the one in 1930s.”

Students said they found the lecture thorough and useful.

Alejandro Rivera, a student in the Graduate School of Arts and Sciences, said he found Turner’s “objective view” of the issue interesting. “It was challenging, and not even slightly political.”

“It was a very informative talk. It explained thoroughly what is going on in the recent economic affairs in the world,” said GRS student Sudipto Karmakar.