Chapter 6Central Banks Are Carrying the Greatest Load and Will Dominate Outcomes

One new phenomenon in this crisis is the role of central banks. On top of negative credit growth, massive central bank intervention is another phenomenon that no one who is alive in the West has seen before. For 20 years, Asia analysts have been watching as the Bank of Japan has tried in vain to alter asset prices by expanding the balance sheet. We submit that central banks cannot alter the path of asset prices; they can only slow the path. As Alan Greenspan said many years ago when someone asked him to define the role of a central bank: “Central banks can only buy time.” We will look at how central banks enter the picture and act as a kind of quasi-banking entity to stabilize asset prices. We will show that without active and aggressive “writing off” of bad assets and bank recapitalization, central banks are simply too small to have any real effect on the financial assets.

Why Have Central Banks Become So Involved in the Solution of the Global Financial Crisis?

A loan is like a tube of toothpaste. Once the toothpaste comes out of the tube, it is impossible to put it back in. So it goes with a loan. When a loan of $100 is given to a borrower, only two things can happen. Either the borrower pays it back in full with principal of $100 and interest of 6 percent (which is $6), for a total of $106 after one year, or the banks have to write off the loan below its initial value of $100 and try to collect ...

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