Thursday, June 16, 2011

Arise Sir Mervyn! No, really, we're serious.

When I first read that Mervyn King, governor of the Bank of England, was getting a knighthood, I thought it was a joke. Like Gadaffi getting the Nobel Peace Prize or Gary Glitter being honored for his work with children. It is an extraordinary decision even allowing for the fact that any senior figure in the public sector seems to get a gong whatever their track record (how long before it’s Lord Brown of Deficitshire?). Talk about rewards for failure.

He certainly can’t have got it for doing the job he is officially charged with. According to their website, the Bank of England’s mission is:

“Setting interest rates to keep inflation low.”

Look a little lower down and you see the current stats: Bank interest rate 0.5% Inflation 4.5%. It is clear that the Bank has thrown away its mission statement and adopted a stance more like “setting interest rates ludicrously low to guarantee high inflation”. Inflation has now been above target for nearly 3 ½ years.

Pensioners, savers and charitable trusts are being mugged with negative interest rates that are quickly eroding the value of their money. Ordinary workers are getting pay rises of 0-2% and are having to cope with food and energy price rises into double figures.

The argument that inflation is down to temporary factors like high oil prices wore thin long ago. It was four years ago when Mervyn wrote this, in a letter to the Chancellor :

“an unexpectedly sharp increase in domestic energy prices” and “weather-induced” high “food prices” had pushed inflation over target, but the Bank could safely “look through the short term volatility in inflation” and was “on track to meet its target in the medium term”.

He said pretty much the same at the Mansion House this week. Four years of the same tired old excuses. If they were serious about inflation, the MPC could put up interest rates, strengthen sterling and lower imported food and energy prices at a stroke.

He has practically admitted that the inflation remit has been sacrificed but claims that the economy simply cannot stand higher interest rates. He thinks we should gladly accept an insidious transfer of wealth from savers to borrowers as the price of recovery. But how strong will that recovery be when the supposed demand boost from low rates is offset by higher prices? Retailers have been lining up to complain about the effect of high inflation (particularly petrol prices) on the spending power of their customers, and this is a direct result of the falling pound, the very thing King and the MPC have been seeking.

But my real problem with Mervyn King is not his current policy choices which are admittedly tricky given that the country is practically bust. It is the choices and miscalculations he made during the boom which preceded the recession and directly led us to this point.

He and Gordon Brown may propagate the myth that some overpaid bankers and sub prime Americans ended the apparently golden economic decade prior to 2007. But the credit crunch did no more than expose the fact that most of the economic growth during that time was illusory - built on a flood of debt and precious little else. Money supply grew by an average 11.9% p.a. between 1996 and 2007.

King was in charge during the boom but did nothing to try and calm it, despite warning signs flashing red: soaring house prices, a credit binge that saw households triple their debts to £1,500 billion, gaping balance of payments deficits, crazy bank excesses and highly leveraged takeovers.

The hangover from all this is what underlies all the economic suffering today. Why did he do nothing? He miscalculated that because retail price inflation wasn't rising too fast then everything was OK. He had his eye on one gauge of monetary health and ignored the bubbles and credit build up around him.

It's a bit like a man driving through a built up area with a dead pedestrian on the bonnet and carrying on as normal because he is travelling under 30 miles an hour: one thing is right so everything must be alright.

You might have thought that the 2008/9 recession would have caused a rethink but, apart from some scapegoating with the banks, nothing has changed. We have the same governor peddling the same low interest rate policy to encourage households to take on even more debt – the goal is £2,100 billion according to government forecasts.

The more astute readers will have spotted that my blog’s picture is not actually Sir Mervyn but his double, Benny Hill. Benny never got a knighthood but perhaps he should have – his comedy might have been bawdy and corny but at least he reliably delivered what was expected of him: laughs. King has been deputy governor or governor for 14 years now and has, by slavishly adhering to the low interest rate orthodoxy of the age, delivered an unsustainable boom, a foreseeable bust and now seemingly endless stagflation. Of course he hasn’t done it all on his own but, after honouring him for this colossal failure, the joke is on us.

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