CentralbankscentralityandNiallFergusson

Our readers would recognize that one topic which appears with inescapable regularity in our writing is the topic of “central banks”. The media engagements of bank chiefs, the policy meetings, the meeting minutes, auctions, OMOs, surveys, the dot plots etc all provide continuous intellectual fodder to writers like us. News on the fiscal side though important remains secondary to the monetary actions for the markets.

Having covered Fed, RBI, BOJ, ECB and BOE, TCB etc extensively in the last few weeks, lets take a step back today and retrace the history of central banking itself and decipher how they became so central to the modern finance. Here it is important to appreciate that the original charters of all such banks across the world were humbler as was the economy which was prevalent in those old times.

Niall Fergusson writes about the central banking history quite vividly in his magnum opus The Ascent of Money. He writes that some 2-3 centuries back, most of the economies were pastoral in nature. The people were living off the land, their requirement of credit was mostly to buy seeds which was duly returned once the harvest happened. The requirement of credit expanded with growth in trade and industrialization. The intrepid businessmen undertaking long and risky voyages across the seas required long term credit. This is where banks in its multifaceted avatar emerged like bill discounters, cheque clearers, short term credit suppliers, collateral managers etc. Once the banking operations got complex, banks set out to source funds for these activities and the advent of deposit taking institutions happened. These institutions offered a return if you are ready to park your money with them.

However, with deposits came one of the most cardinal issues of modern finance. That is the issue of trust. Who will provide that trust? Governments of that day were lean and mostly in the business of collecting taxes to perpetuate their reign (mostly wage war, democracy was still some time away!). Hence arrived the concept of a central bank which was a lender of last resort and banker of the banks.

In a simultaneous development, the expansion in economy and trade encountered the problem of constricted availability of money. Fergusson writes that the money at that time was essentially gold or silver bars, which were in limited supply. To overcome this problem the concept of fiat money got created and suddenly central banks became the custodian of fiat money also. Taking care of its printing and eventual supply.  

The narrative which we outlined above is a highly linear representation of a complex evolutionary process. The journey was not one way or pre-ordained by any means. The distrust for an all-powerful central bank was acute in many places. Political executives were cautious of the oversized influence of a non-elected body. In the US the first two attempts to put in place a central bank failed in the 19^th century. Only in the third try around a century back the Fed came to life. We will pause here; the topic of central banking is vast, and we hope to keep covering it in our notes going forward.

Markets are calm this morning, Indian 10-year yields are down 3 bps as RBI cancelled the last scheduled bond auction for the financial year. The Rupee trades at 72.35. Dollar index cools off below 92 and the US 10-year yield trades at 1.67.