The “Meta” Gray Rhinos Facing the Next
Central Bank Governor:
A Global Perspective
By Michele Wucker
Author of THE GRAY RHINO
During his 15 years as governor of the People’s
Bank of China, Zhou Xiaochuan has gained international
respect for the important part he has played in steering China through the
depths of the global financial crisis that erupted in 2008 and its aftermath,
and today in promoting understanding of the next set of challenges among the
public and other policy makers.
The eve of his retirement offers an
opportunity to reflect on the obvious but unresolved “gray rhino” risks that
lie ahead, and what they mean in particular for his successor at the central
Since the 2008-09 global market crash and
its aftermath, central banks have experienced an era of breaking new ground,
policy experimentation, and the frequent use of the word unprecedented. Also
during this period, central bankers have continued a shift from the old style
of maintaining an air of mystery and leaving the markets to guesswork, to a new
and much welcomed, more open practice of signaling intentions as far in advance
In this context, Zhou has been forthright
about the challenges facing the financial system –China’s financial risk “gray
rhinos” particularly as he detailed in his November 4th article on
the PBoC website. This openness benefits China because it helps to create the
sense of urgency needed to make changes, and to raise public understanding of
policies that are taken to lessen the danger. Some financial gray rhinos
perhaps did not get as much attention in the past because other issues seemed
more urgent, but they are now looming large in the economy.
As a result, it is no
surprise to anyone that China is seeking to reduce financial leverage and
increase liquidity, to lower credit risk from non
performing loans and rising bond defaults, and to address the risks posed by
cross-border shadow banking and financial crime.
Zhou, along with China’s dedicated economic
policy actors, has done a good job in diagnosing the issues, communicating
shared resolve to address a group of related financial gray rhinos in a
systemic way, and creating a real sense of urgency.
There is no space for detail here on the
debates, well documented elsewhere, over how to resolve them and the tradeoffs
involved in macro-prudential policy, regulation, supervision, capital flows, development
policies and so on.
But I do want to look more closely at some
challenges that face the PBoC in particular in its specific role in dealing
with the gray rhinos in China’s financial landscape –and across the globe. In
particular, I mean what I call “meta” gray rhinos: that is, challenges in
processes and systems that create particular obstacles and opportunities given
the policy tools available to a central bank.
Gray Rhinos I: The Nature of the Toolbox
Meta gray rhinos are systemic factors that
can affect our ability to manage gray rhinos involving specific situations. For
example, they might be distortions in decision making processes, resource or
capacity limitations, or structural constraints.
The biggest “meta” gray rhino for central
banks is that their tools are very broad. This makes them very powerful
–essential- in shaping the economic and financial landscape. But it also limits
their ability to address some of the specific factors that affect the central
bank’s success as well as the overall financial and economic outlook.
Thinking of a painting, you could describe
the central bank as the canvas, and the brushes and pigments as the tools of
regulators, supervisors, tax authorities, investors, traders, and
This division of labor means that central
banks often must respond to financial conditions over which they rarely have
precise control. It also creates a feedback loop that includes unintended
consequences that may undermine its actions.
Gray Rhinos II: Independence and Coordination
The more independence central banks enjoy,
the more effective most market players perceive them to be. But, paradoxically,
they also are most effective when working in cooperation with other arms of
In this sense, central bankers also must be
strong advocates for effective policies that often involve economic actors.
Some of the most important of these are fiscal policy, data collection, and
policy: During the financial crisis, governments in
many Western nations chose pro-cyclical fiscal austerity policies that threatened
to prolong and deepen recession. The European Central Bank and the U.S. Federal
Reserve countered with historically low interest rates to fight off deflation.
Most Western governments reduced their budgets and did not take full advantage
of historically low interest rates to implement fiscal stimulus. If they had
done so, the recovery likely would have been stronger and central banks would
have been able to normalize policy sooner.
The latest development offers a particular
challenge to the global economy: the United States has enacted a fiscal
stimulus through a tax cut at a time when the economy is already relatively
strong. At the same time, the Federal Reserve is seeking to normalize monetary
policy. One point of view is that the fiscal stimulus makes it easier to raise interest
rates and reduce the balance sheet. But the resulting double hit to the budget
–from lower revenue and higher interest rates- will create a vicious cycle of
rising deficits and falling credit quality. Few economists expect this to end
gathering: Central banks need accurate information
to make the best decisions. China’s new emphasis on the importance of improving
government data reporting –not a small task- will make the PBoC’s job easier
once achieved. Improving confidence in economic data also is one of the
strongest signals that China’s policy makers can send to international
investors. I can say this confidently from my experience in Latin America in
At the same time, there is a vigorous debate
over which indicators are the most important. For example, many experts rightly
question whether gross domestic product (GDP) accurately reflects economic
health –and what measures might be more effective.
Another example: in general, central banks
around the world have look for wage inflation as a sign of danger, but have
paid far too little attention to asset inflation and bubbles. (This is
particularly important in the U.S. right now, because corporations have
indicated that their priority is to increase share buybacks, further
overheating the market, and not to increase wages.)
Central banks are in a strong position to
shape these fruitful debates by encouraging robust improvement in data
practices and through the selection of data they use and publicize in their
policy: In an economy where policy makers have
prioritized de-leveraging, like China’s, the central bank can offset the
negative economic impact of debt restructurings and writedowns, and the
resulting ripple effect.
Bringing shadow banking and new financial
products under the macro prudential umbrella is an important goal for China. As
regulation and reporting of assets in newly developed wealth management, off
balance sheet financing structures, and online finance, improve, there will be
an adjustment process. Tracking changes in money supply will become more
complicated in the short run, but with greater benefits as time passes.
Gray Rhinos III: Unintended Side Effects
Because monetary policy is such a blunt
tool, central banks create many unintended consequences.
An expansive monetary policy, for example,
hurts savers, benefits debtors, and feeds financial market speculation. Conversely,
monetary contraction –like Paul Volcker’s interest rates to smother inflation
in the 1980s- can drive debtors into insolvency, and without backstopping,
brings down their creditors too, as the Latin American debt crisis threatened
One of the biggest issues today is the side effect
of the past decade’s quantitative easing on economic inequality. It hurts
pensioners and savers and the middle class, and encourages financial
speculation over real economic growth. This rising inequality has led to the
populist waves and xenophobia in the United States and Europe, and will lead to
increasingly dangerous social and political instability if policies do not
change. There has been talk since the crisis of the possibility of central
banks using “helicopter money” –essentially printing money and distributing it
to the wider public. Originally proposed by the American economist Milton
Friedman in 1969, the idea was revived in 2002 in a speech by Ben Bernanke, who
of course later would go on to lead the Fed. It remains a hypothetical idea,
but it is one of few areas in which central banks could directly offset
bubbles. Too many countries have relied far too
heavily on central banks to try to stimulate economies, when monetary policy is
not proving itself to be efficient in helping the real economy grow. By one
estimate, over 90 percent of the U.S. stock market’s rise is the direct result
of quantitative easing. By another, only one fourth of quantitative easing went
into the real economy in the U.S.
liberalization: Extending the financial
liberalization that is one of the hallmarks for which Zhou’s tenure is known
brings both benefits and new risks. A priority for his successor will be to
continue to balance risks and benefits, and to managing the timing of
additional reforms to minimize the potential for shocks.
The benefits of financial liberalization includean increase in the ability to use market
signals to guide investment, thus reducing distortions and efficiently
allocating capital; but it requires close monitoring for gaps created by market
Similarly, financial internationalization
increases the danger of swings in currency values and capital flows, and must
be managed extremely carefully. But it also can deepen and add liquidity to capital
markets. And the infusion of new equity into the banking system can strengthen
capital structures. Increasing the ratio of equity to debt financing across the
economy also can align incentives in new ways, as shareholders and creditors
behave very differently in shaping the future of a company, and in turn the
Internationalization of the renminbi, over
the long term, also will bring challenges like those that face the U.S. Federal
Reserve. Because the dollar is a reserve currency and is used for so many
financial transactions outside of the United States’ borders, the effects of
Fed policies are not as easy to control as in a more closed system.
The Fed’s quantitative easing policies
after the 2008 crisis, for example, provoked protests from Brazil and other
emerging markets protesting “hot money” that distorted their financial markets
and constrained their monetary policies . That reality also muted the effect of
quantitative easing within the U.S. real economy, as funds went outside its
This brings us to a final important point:
the global role of central banks and the challenge a new era of central banking
poses to the PBoC.
Banks and China’s Global Role
For many years, the global economy has
relied heavily –too heavily, some argue- on China to drive global growth. Its
announced shift to a “quality growth model” has perhaps alarmed some investors;
but to those concerned about financial risk, this new model is encouraging.
Post-crisis, China’s policy combined a
proactive fiscal stimulus via infrastructure and other state investments and,
as with other central banks around the world, a dramatic expansion in monetary
supply. This effective approach stood in contrast to the West, which failed to
take advantage of low interest rates to make needed public investments and now
is struggling to find its path forward.
As a result of China’s growing financial
power, its global leadership responsibilities also are rising. With that,
global considerations are becoming an increasing part of challenges for the
PBoC, whose decisions will result in bigger and bigger financial ripples around
These new developments come at a crossroads
for the world’s central banks, which continue to chart new paths following a
decade of bold policy experiments in face of the biggest financial crisis in
most people’s living memory.
Because there is no reliable historical
comparison to the scope of the global quantitative easing of recent years, by
definition all efforts by the world’s central banks to normalize it are
experiments as well.
The financial gray rhinos the PBoC faces in
coming months and years are the same as those facing China’s broader financial
and economic landscapes. But to optimize its ability to addressing them, it
will need to pay close attention to the “meta” gray rhinos that affect its
ability to be as effective as it can in reducing financial risk, maintaining
price stability, and supporting quality economic growth.