In popular myth, King Cnut the Great, more commonly known as Canute, set his throne on the sea shore and commanded the tide to retreat. One version has it that Cnut’s display was a sign of regal arrogance — though if the event ever did occur, it was more likely a rebuke to obsequious courtiers.
Speaking of which, the financial media have been in thrall to a new king of finance since Mark Carney was elevated to the governorship of the Bank of England in July. His procession to office included previous high-ranking positions at Goldman Sachs, the Canadian Department of Finance and the Bank of Canada.
If you’re in the mood for a wry smile, visit the Bank of England’s website. Granted operational independence in 1997, the Bank’s key objectives, other than to print banknotes, are regulation of the financial system, financial stability and monetary policy. Not all the blame for the recent near-collapse of the UK banking sector can be laid at the feet of Threadneedle Street’s Old Lady, since responsibility for banking supervision was transferred to the ill-fated Financial Services Authority under New Labour. But the Bank’s record in monetary policy is entirely of its own making.
In its own words, the Bank ‘sets interest rates to keep inflation low to preserve the value of your money’. In actuality, UK base rates are currently at their lowest level since the Bank was founded in 1694. Not entirely by coincidence, UK consumer price inflation has been running, on average, more than a full percentage point higher than the Bank’s target of 2 per cent, ever since Mervyn (now Lord) King, Carney’s predecessor, took office in the summer of 2003. This might lead the uncharitable to conclude that the Bank is less concerned about fighting inflation than about keeping errant banks on emergency life support. Pensioners and savers can go hang, through a combination of near-zero interest rates and stubbornly high inflation, ensuring a gradual erosion of their wealth in real terms.
But arguably the most pernicious inflation stalking the land is not in consumer prices but in house prices. Anyone living in London will be aware of the pressure; property prices in the capital have risen by up to 40 per cent from their 2009 lows. Nor is this a uniquely south-eastern experience; prices have risen in every region of the UK over the past year aside from the south-west and Wales. Yet Mark Carney, who enjoys a £250,000 annual housing allowance, has even pledged to increase monetary stimulus if financial conditions tighten. What he means is that if rising bond yields threaten to suppress the economy and financial lending (and therefore house price growth), he will throw more stimulus at the market.
This is absurd. The financial crisis of 2007-8 was caused in large part by unsustainable property markets in the US, the UK and elsewhere. Credulous borrowers took on too much debt and credulous bankers encouraged them. The sudden abatement of that frenzy meant that governments had to step in to bail out otherwise insolvent banks. In the process, government finances disintegrated, hence the uneasy half-steps toward austerity undertaken throughout the indebted West. Yet central bankers now seem to believe the best medicine for a financial meltdown triggered by a housing bubble is a new housing bubble. George Osborne’s sudden urge to tinker with his own Help to Buy scheme is an indication of Downing Street’s nervousness about this trend.
But there is only so far central banks can go in the cause of economic stimulus. Traditionally, cutting base rates has always provided a ‘coup de whisky’ for jaded markets. So when base rates are stuck around zero, unorthodox stimulus is required. The Bank of England has provided it, in the form of its quantitative easing programme. For QE, read printing money. We’ve had £375 billion so far and not a whole lot of obvious economic recovery to show for it, other than in the property markets of Mayfair, Chelsea and Belgravia.
Five years on from the collapse of Lehman Brothers, which threatened a second Great Depression, our central bankers are treated as gods. Since there is no counterfactual, we will never know what might have happened if western governments had pursued free market policies and allowed a few bankrupt banks to fail (or be wholly nationalised, rather than perpetuate the illusion of a healthy financial sector). What’s clear is that central bank stimulus has entered hitherto uncharted territory: historically unprecedented base rates; trillions of dollars, pounds and yen conjured up to reconstruct bank balance sheets and support monstrous government borrowing; hyper-aggressive reflationary tendencies that have driven millions of investors into high-risk assets. If economic health could be measured in property values alone, the stimulus has been a success. In terms of maintaining sound currencies or encouraging a climate of confident business investment, central bank stimulus has been a disaster.
It’s time to ask whose interests the central banks really serve. While they pay lip service to the interests of embattled savers, it is clear that their primary function today is to act as lenders and stimulators of last resort to a venal banking system — Danegeld, if you prefer, paid by savers through artificially low deposit rates and channelled to a narrow financial elite. But it will be a pyrrhic victory for Carney and his peers if our banks have been ‘saved’ at the expense of everybody else.
The base rate — the fundamental reference rate for the price of money — is under the control of the Bank of England’s monetary policy committee. What the Bank of England cannot entirely control, however, is the gilt market, which dictates how cheaply or expensively the UK government can borrow money over various terms. Alarmingly for Carney, gilt investors have already voted with their feet. His much heralded ‘forward guidance’ — flashy central bank jargon for keeping interest rates on hold until there is tangible evidence of economic recovery in falling unemployment numbers — has been revealed as farce by rising gilt yields. The market, in other words, does not believe the governor’s pledge. In vowing to keep back the tide, Mark Carney is acting like a latter-day Cnut.
Tim Price is director of investment at PFP Wealth Management.