After Central Banks Steps In

By TAN Kee Wee

(MediaCorp 938LIVE’s Money Talks, Thursday, 27 September 2007, 7.45 am and 7.20 pm)

After the famous ocean liner RMS Titanic struck an iceberg and sank in April 1912, many factors were offered as causes of the disaster.

Some of them were, the excessive speed taken by the captain, faulty design and construction of the ship, and the shortage of lifeboats. There is, however, another interesting factor.

Last Saturday, a tiny key to a binoculars locker on board the Titanic was sold for 90,000 sterling pounds at an auction. This key is special because it might have prevented the Titanic from sinking.

Apparently, the key was in the pocket of Second Officer David Blair, who was transferred off the Titanic a few days before her fateful voyage. Mr Blair forgot to hand the key over to his replacement when he left.

Binoculars were used to detect threats to ships in the days before radar. As a result of Mr Blair’s mistake, lookouts onboard the Titanic had to rely on their naked eyes.

An inquiry after the sinking heard that, had the binoculars been available, the iceberg could have been spotted earlier, and the disaster could have been avoided.

In the current sub-prime crisis, many factors have also been offered to explain the disaster. Were central bankers too focused on inflation? Rather than checking the evolving financial house of cards?

Were the rating agencies the bad guys because they told us that those sub-prime bonds were good? Going back a few years, was Alan Greenspan too slow in raising US interest rates?

Just as in the Titanic disaster, it’s pointless to argue about the causes. We will never know the full answer even after we start collecting our longevity insurance.

But one outcome is certain after central banks cut rates. Such financial disasters will happen again because the stage has been set to create a new bubble, to replace the old one.

But the US Fed really has no choice. If it had kept rates on hold, a recession is likely to follow, maybe even a depression. At least, lowering rates could revive the markets and the economy.

Also, by cutting rates to rescue those reckless investors, it encourages them to be reckless again, since they imagine that they will always be rescued. This is what we mean by the term “moral hazard”.

But central banking has always been about subsidizing moral hazard ever since they were first established in the Seventeenth century. We could avoid moral hazard altogether by doing away with central banking.

But then we would need a monetary system based on gold. This is not possible, unless the global financial system collapses first. Unfortunately, we are all trapped in a system which relies on monetary inflation to keep us going.

This means that another outcome is certain. Our money will continue to shrink in value. As an example of how much money has shrunk, one US dollar today can only buy what 5 cents did in 1914, when the US Fed was first started.

As for the outcome of those reckless investors who caused our financial disasters, more often than not, they escaped punishment. This is because no one is certain that they are the only ones who are responsible for the disasters.

Mr Blair, the Titanic officer who made the mistake, also escaped punishment. He kept the locker key as a momento and gave it to his daughter, who in turn gave it to a sailors’ association. The money raised from last Saturday’s auction will now be used to set up scholarships in his honour.