Banker to central bankers

Interview with Mr Agustín Carstens, General Manager of the BIS, conducted by Mr Vikram Khanna from the Business Times and published on 24 March 2018.

Even before he turned 50, Agustin Carstens was a veteran at handling economic and financial crises, as a central banker and finance minister. Two years after he started his career in 1980 at the Mexican central bank, Banco de Mexico, the country defaulted on its external debt, triggering Latin America's debt crisis, which was to last for the better part of a decade. In 1994, he was in the thick of what came to be called the "Tequila Crisis" set off by a massive devaluation of the Mexican peso, which brought the country's financial system to its knees. During the global financial crisis of 2008, which devastated the Mexican economy, Mr Carstens was again on the frontlines, as the country's finance minister - a job he described as the most difficult he has done. ("You have to tax people, you have to get used to saying no, and then you have to deal with political life.")

As central bank governor from 2010 to 2017, he guided the Mexican economy through collapses in oil prices and repeated plunges in the value of the peso - including during the 2016 US election campaign and after. In between, he served as deputy managing director of the International Monetary Fund (IMF) for the three years to October 2006. Through all the tumult he has had to deal with, Mr Carstens is reported to have never lost his cool or sense of decorum. MAS managing director Ravi Menon, who knows him well, has described him as "a gentleman, even by the high standards of central bankers".

Since December last year, Mr Carstens, 59, has been general manager of the Bank for International Settlements (BIS). Founded in 1930 - 14 years before the IMF and the World Bank - the BIS is a somewhat mysterious institution. In his book about its history, Tower of Basel, the author Adam Le Bor described it as "the secret bank that runs the world". Mr Carstens acknowledges that the BIS is "very important and very discreet" and adds: "Its main banner would probably read 'The Bank of Central Banks'."

BIS and its influence

Owned by 60 central banks which are its members, the BIS has three main functions: it is a forum for collaboration between central bankers, especially in the design and implementation of monetary policy; it helps central banks manage their international reserves, and it hosts various committees that construct key financial regulatory frameworks which govern banking globally, such as Basel I, II and III.

Although the BIS has no enforcement role, its influence is enormous. It facilitates joint actions by central banks, which can be critical for the global economy. For example, Mr Carstens points out, during the global financial crisis of 2008, the reaction of central banks was crucial. "At that time, dialogue among central banks was of the essence. And while it would be presumptuous to say that all the dialogue happened in the BIS, a fair amount of it did happen there."

Sometimes the BIS challenges the prevailing views of central bankers. For example, in 2003, it pushed for pre-emptive tightening of monetary policies to prevent the build-up of dangerous asset bubbles. Its advice was not taken and five years later, asset bubbles burst in the United States and Europe, leading to the global financial crisis.

"The BIS doesn't want to rock the boat gratuitously," explains Mr Carstens, "but at the same time, if we see something has the potential to lead to unintended consequences, we feel obliged to say so to our shareholders, the central banks. Sometimes our views might not coincide with those of our masters, but that is something we should be prepared for. But that also shows the maturity of the central banking community: they're willing to tolerate an institution that they sponsor which challenges their views. Usually it's a very constructive dialogue."

Mr Carstens explains why the views of the BIS and central banks can differ: "In Mexico, a very popular sport is bullfighting. As spectators, we watch bullfights from the stands. But we are not the bullfighters. In the economy, the bullfighters are the central bankers - they really know how things are. As spectators, we might not have all the information. Certainly we don't have the political knowledge; monetary and forex policies happen in the broader context of public policy, and politics can play a role. So, for example, sometimes, a central banker might say to us: 'Yes, I agree with your recommendation, but I don't have the power to do that right now'."

Launching unconventional monetary policies - near-zero interest rates in all the major economies, which continued for a decade - was a courageous decision by central banks, says Mr Carstens, and the results have been "so far so good". Even though the US Federal Reserve has started to tighten, monetary policy remains accommodative - not only in Europe and Japan, but even, still, in the US, which helps explain why markets have remained ebullient.

Missing inflation

But given the large amounts of liquidity being pumped in when economies are recovering, why is inflation nowhere on the horizon?

"There is a phenomenon that we call 'missing inflation'," says Mr Carstens. "Because if you take into account the fact that unemployment in the United States is very low, previous experience suggests that at this stage in the business cycle we should be seeing inflation at a higher level. But that is not so, neither in terms of inflationary expectations nor actual inflation."

So why is inflation missing? The BIS hypothesis, he explains, is that technological change has reduced the capacity of companies to adjust prices in many sectors. Together with globalisation, it has also put downward pressure on wages. Both these forces have caused inflation to remain stubbornly low, despite efforts by central banks to boost it.

A safer system

Although not all economists would agree, Mr Carstens takes the view that the financial system is much safer now than it was before the global financial crisis.

"We now have the financial stability board, or FSB, which is completely devoted to issues of financial stability," he points out, referring to the body established in 2009 to monitor the global financial system. "And the FSB has political legitimacy because it reports to the G-20 - it's not only a gathering of governors, ministers and bank supervisors - they report to the head of state level at the G-20."

Some of the post-crisis reforms have also been far-reaching, he adds. "Capital and reserve requirements are higher, there are limits on leverage, it's more difficult for financial institutions to fudge certain figures and there is now a framework to do bank resolutions - that is, deal with bank failures. All of that amounts to a lot of progress. So systemically, we're safer."

But Mr Carstens points to new challenges too: One is that as regulators tightened the screws on banks, the non-bank financial system grew fast, leading to increases in household, corporate and government debt. Most of the additional leverage came through non-banks (which cannot take deposits but can extend credit) such as finance and leasing companies, mortgage lenders and investment funds.

Fintech challenges

The rise of fintech also poses new challenges, Mr Carstens says.

He acknowledges that fintech firms - which are nimble, innovative and provide a variety of financial services - can offer many benefits, including dramatically lower transaction costs (such as costs of remitting money), more efficient financial intermediation (such as matching savers with investors) and better access to financial services for large sections of society which are currently "unbanked".

But there are also potential problems. In particular, he is concerned that financial authorities may not clearly understand the risks attached to some of the services being offered by fintechs, leading to unforseen accidents and then delays in the adoption of financial innovations.

As a former central banker and finance minister, Mr Carstens has had first-hand experience of dealing with fintechs. "Many people in the fintech industry would come to me and say: 'Look, I have this application, I have this innovation, it will produce all these wonderful results. But you need to change the regulations to allow me to operate'.

"Well, of course, things are not that simple. Authorities need to be able to see through the veil of technological innovation and identify the risks involved. And if those risks are well taken care of, then fine, we should go ahead with the financial innovation. But if the financial innovation is a way to mislead clients or if risks are not well taken care of, the authorities need to intervene. All in all, fintech should be very positive. But some activities should not be tolerated, or should be regulated."

There is also "this other" dimension, he continues. "There is a formal part of the financial system, the regulated sector, and we act very heavily on them. Then there is this other sector, which includes the fintechs. Their complaint is that since they are innovating, they should get more lenient treatment. But we cannot afford that. There must be the same rules for all players across the financial system. Same risk, same regulation."

But then how can authorities encourage financial innovation?

"What is being done in the MAS is a good example to follow," notes Mr Carstens. "The authorities here do not feel threatened by innovation. Their attitude is 'let's understand what it is, and let's deal with it accordingly'. But that is not always the case elsewhere - not all authorities have the same expertise, the same technical abilities as the MAS."

Another innovation that the BIS is studying is digital currencies. One form of such currencies are those issued by central banks, which are distinct from privately created so-called cryptocurrencies such as bitcoin.

Mr Carstens says that at the wholesale level - that is, for interbank transactions - central banks are already using digital currencies and they should do more, including through the use of blockchain technology. But he is sceptical of the idea of central banks issuing digital currencies at the retail level. "That would mean everybody would be able to open an account with the central bank, which would be risky, because it would hit the commercial banks. People could put all their deposits with the central bank. And what would central banks do with all those resources? Obviously they cannot provide the same levels of service as commercial banks. Also, would you want central banks to do financial intermediation? That is not their role."

Crypto-assets, not currencies

Cryptocurrencies, which are becoming increasingly popular, is also a topic on which Mr Carstens has spoken at length, and with uncharacteristic bluntness.

In a speech at Goethe University in Frankfurt in February, he condemned bitcoin as "a combination of a bubble, a Ponzi scheme and an environmental disaster", adding that "the volatility of bitcoin renders it a poor means of payment and a crazy way to store value".

In our conversation he suggests that, first of all, bitcoin and its ilk should be called "crypto-assets".

"Because it's clear that they don't qualify as currencies. They are not a good unit of account, medium of exchange or store of value. Therefore they cannot be currencies.

"They are assets and people can invest in them if they want. But they should bear the consequences of their actions.

"More fundamentally, the trust that society should have in a currency should not depend on the technology on the basis of which the currency is produced. Just because bitcoin is produced by a technology that can be calibrated differently with different results does not make it a trustworthy currency.

"So if these cryptos are not currencies but assets, then they should be treated in the same way as other assets. There is a strong case to be made for consumer protection and investor protection. Because many of the algorithms which produce these crypto-assets are not transparent, so people just don't know what they are buying. So I think it's fine for people to offer different assets, but they should be subject to the same regulations and the same rules around transparency. That's why the issues of consumer protection and investor protection are important."

Finally, Mr Carstens points out that crypto-assets should not be allowed to facilitate illegal transactions. "A good avenue to limit their growth is to regulate at the point where they interface with the regulated markets, such as crypto-exchanges. It is also good that commercial banks have said: 'We will not accept payments of credit cards with bitcoin or we will not have ATMs where you can take out cash from your bitcoin account.'

"The fact is that many of the crooks who, for example, launder money prefer to use bitcoin to cash. Now they have a better technology to do their transactions. Should we tolerate that? My answer is no."

Fighting protectionism

Although trade policy does not come under the purview of the BIS, as an economist and a policymaker, Mr Carstens is concerned about protectionism, which is rising around the world - including in the US, which was once a bastion and a champion of free trade.

"We have done a lousy job in selling globalisation and free trade," he says. "People on the street do not really understand the benefits."

According to Mr Carstens, part of the problem also lies in the nature of the constituencies for and against free trade. "Some people can clearly see the benefits of free trade when they are exporting. But in countries that are net importers and have a deficit, the beneficiaries of imports are very atomised in society.

"So, for example, the fact that Americans can go and buy cheap imported sandals in Walmart does not motivate them to speak out in favour of free trade, but a unionised automotive worker who has lost his job because foreign cars are more competitive has a strong voice. The minority who have suffered the consequences of trade are more concentrated. It is easier for them to organise and speak out - and their voice has been heard.

"And not only have we failed to sell globalisation well, we also didn't take care of those who have been affected in the transition to a more global economy. There are many people who have been affected by technological change and globalisation who don't have a clear way to reinvent themselves. So there are tragic cases in many parts of the world - people in broad sections of society who are not able to find a job.

"So even though I don't doubt the benefits of globalisation, in implementing the liberalisation process, we didn't pay enough attention to these negative side effects of globalisation. And now, they're hounding us."