Understanding Central Banks

Understanding Central Banks

Central banks are at the heart of their country’s economy and play a key role in the global markets. Their importance is particularly relevant when trading the Forex, as they often set the reference for funds and traders activity. If you are still unsure why interest rate releases can throw the markets in a maelstrom, then here is a little guide to help you understand better.

What are central banks?
Central banks are institutions responsible to produce and manage the money used by their respective countries. Most major central banks are independent, meaning that they are free from the influence of the government. Some of their functions include lending money to other banks, lending money to governments, printing physical money, and ensuring monetary stability through monetary policies.

Each central bank has a monetary policy. A monetary policy is the process by which banks achieve their objectives. Nowadays, a common objective is to maintain inflation at a certain level (usually 2%), but other objectives exist. In order to achieve their goals, central banks have different tools, two of which are controlling interest rates and open market operation.

Interest rates
The interest rate is the rate at which the central bank lends money to other banks. By changing the interest rate, it can influence both the country’s inflation and currency. For instance, if prices increase too fast the bank will want to reduce inflation by increasing the interest rate. If the economy is in a slowdown and there is not enough spending, then the bank can lower the rate to increase inflation.

Controlling inflation through interest rates also affect currencies. A higher inflation reduces the purchasing power of a currency and it loses value with respect to other currencies. On the other hand, lower inflation increases a currency value.

However, timing is an important issue when studying the effect of interest rates on currencies. Increasing or decreasing rates can be an indication of a country’s economical state. For instance, if the ECB (European Central Bank) decides to increase the interest rate after an economical downturn, traders can see this as a sign of recovery in Europe and drive the Euro up. The inverse is can happen as well. This is why it is important to analyse the context for each monetary policy release before any trading decision.

Open market requirements
Central banks can also intervene by executing operations on the market. They buy or sell currencies, bonds, or even securities to control the amount of money in circulation in order to achieve specific goals. Take for instance Canada’s economy, which relies heavily on US exports. Canada’s exports could suffer from a strong Canadian dollar, since the Americans would have to pay more to purchase its goods. Hence, the Bank of Canada can decide to sell large amounts of its own currency to lower its value and bring back exports to satisfyingly levels.

How can traders profit from central banks?
Unless your name is George Soros, you can’t afford to fight against central banks. So the best thing for traders is to trade in the same direction as them. The beautiful thing is that they won’t try to hide their intentions – in fact it is quite the opposite. They want to divulge their intentions so that they can receive help from traders in moving the market. Remember that the Forex is the largest market in the world, and influencing the value of a currency requires very large forces. That’s where traders can join in to help a bank move a currency to a certain level.

Now, this is more relevant for long term trading strategies, but even for those trading shorter time frames, it can help to know which way the market is heading and develop a long or short bias. So it’s a good idea to keep a close eye on central banks’ conferences, news releases, and interviews to determine their point of view and trade accordingly.

Which central banks should you track?
You should track any bank which has an interest in the currency you are trading. The Federal Reserve which controls the U.S. dollar is a must watch for any Forex trader since its action influence the entire market.

Central Bank Power And Its Limit

Central Bank Power And Its Limit

The euro will not dissolve, and the U.S. Treasury can borrow as much money as it wants while paying practically no interest, all because a couple of central bankers say so. That’s real power.

But companies are not hiring, consumers are not spending, governments are sinking deeper into debt, and American workers are abandoning fruitless job searches in droves, despite years of effort by those same central bankers to make things better. That’s where central bank power meets its limit.

The European Central Bank and its U.S. counterpart, the Federal Reserve, can create money and put it into circulation by lending it out. This, combined with their ability to set target levels of interest rates – in effect controlling the price of money they create – is how central banks affect our daily lives. When money is too scarce and expensive, economic activity is choked off. When money is cheap and plentiful, consumers and businesses are supposed to be able to borrow and spend freely, stimulating demand and creating jobs. But too much money circulating too rapidly breeds inflation. Central bankers try to achieve a balance.

The system is not working very well right now.

On both sides of the Atlantic, governments have developed enormous appetites for low-cost money, which only the central banks, using their ability to create funds out of thin air and lend at whatever price they choose, can satisfy.

In normal times, governments that run budget deficits simply issue bonds that pay a fair rate of interest, and investors – ranging from private citizens to foreign central banks – buy the bonds, because they believe that a well-run government presiding over a healthy economy will be able to repay the money. When confidence in government creditworthiness falters, investors demand higher interest rates, or they take their money elsewhere.

This is what happened in Greece, Ireland and Portugal before they sought bailouts from their eurozone partners. It is what is still happening in Spain, which has so far asked for limited assistance for its banking sector, and in Italy, which has thus far not asked for assistance. Italy and Spain are the third- and fourth-largest euro economies, after Germany and France. Providing major assistance to them is beyond the resources of every existing institution except the ECB.

So it was big news when ECB President Mario Draghi declared that his bank is prepared to buy unlimited quantities of Spanish, Italian and other government bonds in order to keep government borrowing costs low. Draghi promised that the central bank would “sterilize” this massive intervention by withdrawing similar amounts of cash elsewhere in the financial system in order to prevent inflation. He also said that, in order to benefit from the artificially low rates the bank will produce, countries will have to request assistance from Europe’s financial rescue fund. The fund will have the power to impose budget austerity and demand economic reforms that national parliaments have been reluctant to produce on their own.

“We say that the euro is irreversible,” Draghi said. “So unfounded fears of reversibility are just that – unfounded fears.” (1)

But, as Bloomberg reported, Draghi also offered a realistic assessment of the central bank’s power in insisting that governments will have to undertake reforms to make the effort to save the euro work. “There is no intervention by the central bank, by any central bank, that is actually effective without concurrent policy actions by the government,” he said. (2)

It is not clear that Ben Bernanke and his colleagues at the Federal Reserve agree. In the wake of a dispiriting August jobs report, the bank’s policy-making Federal Open Market Committee is expected to announce additional steps to try to stimulate hiring. My guess is that these steps will involve the Fed purchasing longer-term Treasury bonds and possibly other instruments, such as mortgage-backed securities, in what would be the third round of major financial stimulus since the financial crash four years ago. Financial analysts have expected these steps, which they have already dubbed “QE3” (for “quantitative easing”) for months, and Bernanke signaled at a recent financial conference in Jackson Hole, Wyo., that he was preparing to act on further signs of hiring weakness. The jobs report was probably all he needed to pull the trigger.

Bernanke and his allies on the Fed seem to believe that they have to take action, despite the obvious signs that already ultra-low interest rates are not having the desired effect. Unfortunately, our problem is not that interest rates are too high, so the solution does not lie in reducing interest rates further.

Granted, record-low mortgage rates are helping the housing market find a bottom and even begin to recover in some cities. But the effect has been small, because so few people can actually get mortgages. Banks have heard the “no more bailouts” message loud and clear from politicians of both parties. Almost any loan officer in America will tell you that, public statements to the contrary, most financial institutions want to lend in only the most bulletproof situations, to borrowers who are the least likely to ever default. The banks probably have good reason to fear second-guessing by regulators if they loosen their standards, and they also have a lot of unhappy experience trying to foreclose on defaulted borrowers with imperfect paperwork.

The same is true for commercial loans to small businesses. Despite very low stated interest rates, many borrowers cannot get money. Businesses that need capital to expand can’t get it. Businesses that have capital in the form of big cash reserves don’t put it to use, because they have no confidence about future demand.

So most of the cheap credit the Federal Reserve is providing goes to the Treasury, where it funds our $16 trillion in accumulated debt at the lowest possible cost. Like the ECB, the Federal Reserve can use its power of money creation to ensure that our government never defaults on its debt, but it does not have the power – short of allowing a default – to force politicians to make good policy choices.

The situation reminds me of a leaky ship, with the central banks acting as pumps that get the water out of the bilges. The pumps buy time that can be used to make needed repairs. But if you don’t fix the leaks, they just get bigger. Eventually the ship goes down. No pump in the world has the power to prevent it.

The Central Bank’s Relationship With the Economy

The Central Bank’s Relationship With the Economy

The central bank has two very important functions within the economic system of a country. The first is to preserve the value of the currency and maintain price stability, its primary tool for this purpose is the management of interest rates. When using the gold standard, the value of banknotes issued by central banks was expressed in terms of gold content, or possibly someone else, the bank tried to maintain certain levels over time.

The second is to maintain financial system stability, since the central bank is the bank of banks, their clients are not ordinary people or specific companies, but the State and existing banks within the territory of the nation to which it belongs. The central bank takes deposits from its customers and keeps them in accounts which they have in him. With these transactions for clients’ accounts with other banks through the payment and clearing systems (SNCF, TARGET2), as an individual in a commercial bank account used for transactions with another individual. In turn, the central bank also provides loans to banks with liquidity problems, or to other states.

Normally, in circumstances of war, governments in a country solve their financial needs with its own central bank.

Central banks are in

* Custodians and administrators of the gold and currency reserves;

* Providers of legal tender;

* Perpetrators of exchange rate policies;

* Responsible for monetary and price stability;

* Service treasury services and financial agents of the Public Debt of national governments;

* Advisors to the Government, reports or studies findings.

* Auditors of conduct and publish statistics related to their functions;

* Lender of last resort (banks banks);

* Promoters of the proper functioning of financial system stability and payments systems;

* Supervisors of the solvency and compliance with current regulations of credit institutions, other entities or financial markets whose supervision is under his tutelage.

All these features and functions lead to central banks have a large influence on the economic policy of countries and which are a key element in the functioning of the economy. These control the monetary system, ie the money circulating in the economy, while avoiding adverse effects to occur as high levels of inflation or unemployment, the credit system through the regulation of interest rates that banks offer or charge their clients and the bank reserve that require banks and other financial institutions and exchange rate system, controlling the local currency’s value against foreign currencies.

Markets, Economies, Central Banks – All Out of Power

Markets, Economies, Central Banks – All Out of Power

Having topped out into corrections in March and April, most global markets rallied back some in June, fueled by hopes that June’s unusual schedule of promising events would provide rescues for the eurozone and the U.S. economy. As those events arrived, if one or two failed to produce results, the rally only paused momentarily as there were still remaining events that might produce results.

But now we’re out of promising events for a while.

June’s first hope was that Spain would receive its requested bailout loans for its banks and Spain would go away as a worry. Next was the scheduled election in Greece that might prevent it from exiting the euro-zone. Then the G-20 summit on June 19 was hoped to produce a big coordinated global stimulus effort, and the Fed’s FOMC meeting was anticipated to result in new QE3 stimulus efforts for the U.S. economy. That was closely followed by the EU summit meeting and hope that it would result in a promising plan to control the eurozone debt crisis. This week it was that the European Central Bank and the Bank of England would cut interest rates at their meetings.

Markets won some, lost some.

Spain did receive the bailout loans for its banks. But the market’s euphoria lasted less than a day before it was realized that Spain’s government debt crisis was worse than its banking crisis.

The G-20 summit produced nothing except an agreement to continue to monitor conditions. The Fed’s FOMC meeting produced only an extension of the current ‘operation twist’ (which was already failing to halt the economic slowdown).

However, it seemed to get a big win last week from the EU summit, a major agreement to allow European banks to borrow directly from the established rescue programs, for the bailout funds to be used to buy the bonds of individual countries having difficulty selling their bonds to investors, and giving the European Central Bank more control over the rescue funds.

Unfortunately, the excitement over the agreement was short-lived when it was realized that much of the promised action would be delayed until the details are worked out later in the year.

But both the Bank of England and the European Central Bank came through with the hoped for interest rate cuts on Thursday. The Bank of England even included a degree of QE3 stimulus by adding to its bond-buying program. And China’s central bank chimed in with an unexpected rate cut of its own.

Unfortunately, markets had apparently already factored those central bank actions into prices since they declined on the news, apparently also concerned about the next event, Friday’s U.S. monthly employment report.

And that jobs report was a disappointment. Only 80,000 new jobs were created in June. New jobs therefore averaged only 75,000 a month in the 2nd quarter, down a big 66% from the average of 226,000 in the first quarter. That’s on top of all the other economic reports showing the 2nd quarter to have been much worse than the 1st quarter.

So the economy continues to run out of steam at a worsening pace.

The lack of positive response to the further monetary easing by central banks, and the biggest effort yet from the EU summit to contain the euro-zone debt crisis, indicates that central banks have also run out of firepower.

Can markets be far behind?

Consider also that ultimately stock prices are driven by corporate earnings, and Thomson/Reuters reported this week that warnings from corporations that their 2nd quarter earnings will not meet estimates are at the highest level in ten years.

Bullish analysts are confident the dismal jobs report will force the Federal Reserve to rush in with the additional QE3 type of stimulus program they failed to produce at their FOMC meeting two weeks ago.

But the Fed was already reluctant to try to come to the rescue. In testimony before Congress Fed Chairman Bernanke denied that it was because the Fed has run out of ammunition, even though the positive effect of QE2 in 2010, and ‘operation twist’ last year, each lasted only six months before the economy ran into trouble again.

Now it faces the fact that the additional monetary easing by central banks in Europe on Thursday seems to have had no effect in reassuring markets, at least so far, with markets down two days in a row after the actions. That may have the Fed even more reluctant to follow with similar action. After all, if the Fed fires off what ammunition it may have left and it fizzles, what if more is needed down the road? It may be better to wait and keep markets hoping they still have something left for down the road “if needed”.

My forecast at the beginning of the year was for the market to top out in April into a tradable summer correction, and then launch into a substantial rally in the market’s favorable season beginning in the October/November time-frame.

I could be wrong. But so far, short-term rally attempts notwithstanding, it seems to be working out that way. June’s rally is beginning to look like a rally to be sold into, another opportunity for short-selling and profits from downside positioning in inverse etf’s.

Inflation – Central Banks Control, The Cure

Inflation – Central Banks Control, The Cure!

Inflation is created by directly increasing the money supply in an economy. When this happens it creates a watering down effect on the money supply. If you take newly created dollars and add them to the money supply of the country, along with all the other dollars that were already there, you get the total money supply. The larger new money supply will actually be worth less in purchasing power than the total supply of money before, which had fewer dollars in it before the additional money created was added. It costs more in dollar terms for goods and services, not because these things are worth more money but because it takes more dollars to buy them as the dollar’s value now is less. In simple terms that is inflation.

How is the money supply increased?

Central Banks –

Central Banks such as the Federal Reserve Bank for the United States are in charge of creating money. The US dollar is the same as all other global currencies in the world today. The dollar and all other fiat currencies are backed by nothing more than the faith and promise of the government who prints it and the faith in its people who use it. Central Banks such as the Federal Reserve can “print money out of thin air.” Simply but pressing the “start button” on their printing press.

Central Banks use different tactics in controlling the supply of money. But the one thing to be sure of is that these tactics that are used, are always controlled in the best interest of the banks. Governments and their citizens always play second fiddle when it comes to the banks being in charge. When money is printed the central bank earns interest on each banknote or dollar bill printed.

The Cure –

One cure to keep inflation under control permanently is to force government law makers to do their jobs. First by forcing them to pass new legislation that removes the power from the central bankers on money printing. Thus handing the governments back their own power to create and control the money supply through the US Treasury and alike. Next “Sound Money” once again must be injected into society. Sound money is real money that has been backed by tangible assets such as physical gold or silver.

Additionally further legislation needs to be created and passed that will abolish these private banking cartels. Including entities such as central banks like the US Federal Reserve Bank which is a privately owned bank. Furthermore there is nothing federal about the Federal Reserve except a cleverly placed name.

Taking the control away from the powerful banking elite is paramount. As for decades these private banks have been heavily profiting by controlling governments and funding wars completely outside both the government and general public’s view. Worse yet they have never been required to answer any questions from anyone inside or outside government to justify any of their actions