The Bank of England's in danger, and not for the first time...
AS A POLITICAL CARTOON by James Gillray reminds us each morning, hung by the door here at BullionVault, the Old Lady of Threadneedle Street has come under attack from politicians before.
And today, just as in 1797, the men in Westminster have got their hands on her treasure chest at last...
The Baker Library at Harvard Business School picks up the story:
"[Gillray's etching is a] satire on the suspension of gold payments by the Bank of England. Prime minister William Pitt was forced to implement the issue of paper money when the Bank announced a gold shortage, due to loans it had made to finance the war with France.
"Rumors circulated that the Bank's coin was merely being held in reserve to send to the Continent in support of the war. Hence the significance of the locked chest, and the coins in the pockets of the lady's paper money dress."
In Gillray's cartoon, he nicknamed the Bank of England the "Old Lady of Threadneedle Street", the first recorded use of the nickname. The tag has stuck ever since – and in his satire, Political Ravishment, the Old Lady's in danger.
"Murder! Murder!" she cries. "Rape! Murder! O you villain! What, have I kept my honour so long to have it broke up by you at last? O murder! Rape! Ravishment! Ruin! Ruin! Ruin!!!"
Fast forward 210 years, and now Mervyn King – an affable career academic from the English Midlands – is wearing the dress. The current prime minister is after the Old Lady's honor, too. Political ravishment of her virtue spells disaster for the British Pound.
Should you be looking for a bolt hole outside the Dollar, be sure you avoid ruin on Threadneedle Street. The Gold Price says the British currency is doomed, rising 10% for UK investors wanting to Buy Gold in the last month alone. Here's why.
A graduate of Cambridge and Harvard universities, Dr.King taught in Birmingham (UK) and the London School of Economics before becoming deputy governor at the BoE in 1998. Moving to the top job five years later, he learnt his chops as right-hand man to Sir Edward George, the much-respected old hand who steered the central bank on a "steady" course for the second-longest tenure in history.
Dr.King, in other words, had a tough act to follow. Sound familiar so far?
"Steady" Eddie George ran the Bank of England for ten years, during which time the British economy enjoyed an historic run of unbroken growth. Its longest boom in the modern era came despite hiccups and risks including the Asian Crisis, the collapse of Barings, the Russian default, LTCM, the collapse of BCCI, the DotCom Crash, 9/11 and the Deflation Scare of 2003.
Loved by the press and politicians alike, Sir Eddie led the Bank of England on its finest day, 6th May 1997. On that auspicious morning, the incoming New Labour government finally gave the Old Lady her full independence in setting UK interest rates. Now the Bank of England would have free rein to manage the British currency without political meddling from Whitehall or Westminster. (George's predecessor had been hand-picked as a "yes man" by Margaret Thatcher; he once suffered the indignity – according to colleagues – of being told by telephone that her government had changed the UK interest rate.)
The Bank's independence in May '97 marked a "spectacular beginning" for the New Labour government, said Sir Eddie. Indeed, he gushed during an after-dinner speech in the City that "it demonstrated, as clearly as anything could have done, [the government's] commitment to stability and long-termism in the British economy."
Has independence for the Old Lady paid off? Just like his Fed colleague, Sir Alan of Greenspan, Sir Eddie's stint in the frock of Pounds Sterling still looks great at first glance. Famed for his affable wit, he presided over average GDP growth of 2.8% and average inflation of just 2.5%...less than half the rate endured by his predecessor in the '80s.
That meant he could keep pushing interest rates lower, continuing the cheap money trend begun as inflation fell back at the start of the '90s. By mid-2003, the cost of Pounds Sterling was slashed to a four-decade low.
But "did George's hard-won stability in inflation and growth come at the expense of instability elsewhere?" as Evan Davis, business editor at the BBC, asked when Sir Eddie left the Bank in June 2003.
"After all, Sir Edward's tenure has been associated with an overvalued exchange rate and soaring consumer spending. The high exchange rate kept import prices down; that in turn partly explained the low inflation. But that also created the conditions for consumers to import and spend."
Yet more familiar again, right? Importing and spending by British consumers has since taken the trade deficit to fresh all-time records. Household debt now towers above a whole year of gross domestic product.
But here in 2007, comparisons between the right-hand men who took over when Greenspan and George left have recently failed. Sir Eddie's successor has drifted off-message.
We just saw the new boy at the Fed stick to the script of his predecessor, Alan Greenspan, slashing interest rates and fighting to "forestall" the debt-led recession that's now long overdue. But Mervyn King? He's lost the plot – and is no doubt seeking a nice quiet professorship for the start of the new academic year in October.
Dr.King's failure to do what's required – at least in the minds of politicians and his central bank colleagues – should come as no surprise, however. After all, this is the guy who kept voting for tight money even as the Greenspan Fed slashed US rates to their emergency low of four years ago. He stayed out of step with his Bank of England associates even after he became governor, outvoted twice by his own team, in fact, when he pushed for higher rates in Aug. 2005 and in June '07.
Yes, King failed to prevent soaring inflation of the UK money supply. Since he took over as the Old Lady's defender, annual growth in new lending to non-bank financial companies has risen at a double-digit rate. It hit 30% growth year-on-year twice in 2006.
But with King gone – and gone soon – the Pound Sterling risks being left with just political "yes men" to defend it on the Monetary Policy Committee. That will prove no defense at all.
"The moral hazard inherent in the provision of ex-post insurance to institutions that have engaged in risky or reckless lending is no abstract concept," Dr.King told the British Parliament in an open letter in early September. Pointing to the crisis caused in the banking sector by the need to refinance short-term debts amid the credit crunch, "the risks of the potential maturity transformation undertaken by off-balance sheet vehicles were not fully priced," he went on.
"If central banks underwrite any maturity transformation that threatens to damage the economy as a whole, it encourages the view that as long as a bank takes the same sort of risks that other banks are taking then it is more likely that their liquidity problems will be insured ex-post by the central bank. The provision of large liquidity facilities penalizes those financial institutions that sat out the dance, encourages herd behavior and increases the intensity of future crises."
Does that smack of sound thinking to you, a level-headed response? Mervyn King's walked the walk of strong moral policy, too – refusing at first to lend emergency funds to the money markets as they froze in August. He also refused, for a while, to accept mortgage-backed bonds as collateral from struggling borrowers.
But the crisis at Northern Rock, one of Britain's most successful and aggressive mortgage lenders during the Housing Bubble of 2002-2007, has finally forced a series of dramatic U-turns. Delaying a bail out of London's most profligate bankers will cost Dr.King dear.
First, the big banks in London side-stepped the Old Lady's refusal to inject emergency funds, simply bidding instead for cheap money from the European Central Bank in Frankfurt. Last week the ECB lent a record weekly sum of €75 billion in extra three-month funds, and from around 140 banks bid for the cash – says the Financial Times Deutschland – a good chunk of those emergency loans went to British banks bidding via their European subsidiaries.
Next, the Old Lady blocked an offer from Lloyds TSB, the only AAA-rated bank in the United Kingdom and a stolid, boringly safe institution, to buy Northern Rock – mortgage book, debts and all.
Why stymie a free market solution to the crisis? The details have yet to emerge, but the Bank of England itself then offered to step in as "lender of last resort" – and that only caused savers to start a run on the bank, queuing out on the pavement!
It took the government, led by finance minister Alistair Darling, to calm the panic on Monday 17 Sept., when – in a truly historic move – he gave an absolute guarantee to Northern's depositors that their money would be insured by the taxpayer.
By now, Dr.King was beginning to look both detached and impotent. But ahead of speaking to a government committee on Thursday, things only grew worse.
"Allowing this situation to develop openly and publicly has been a disaster and lessons have to be learnt," warned one member of parliament. "I want to know more about the sequence of events at Northern Rock," said another. "King has got some explaining to do," added a third.
Then, two days after the government bail-out, the European Commission in Brussels said that the state's support for Northern Rock may be illegal under EC competition law. That only made Dr.King's position more precarious still. Because if he'd fixed this mess with cheap cash in the first place, the thinking will run, then nationalizing Northern Rock's balance sheet wouldn't have become necessary.
And then, finally – and also on Wednesday – Dr.King's vow to lend emergency cash only for short periods, and to accept only government bonds as collateral, was reversed in a humiliating U-turn. The Bank of England announced "that it plans to conduct an auction in which it will provide funds at a 3-month maturity against a wider range of collateral, including mortgage collateral, than in the Bank's weekly open market operations."
The first auction would be held a week later, with three further auctions over the three weeks following, putting £10 billion up for grabs ($20bn) each time.
In short, moral hazard hit London at last – and it's being funded by the Old Lady herself.
"This is exactly what [the Bank] said it would rather not do in [King's] letter to the Treasury Select Committee," notes Alan Clarke, analyst at BNP Paribas. "Clearly the financial market situation has deteriorated to the point that the slowdown implied for the economy is more severe than the Bank had seen as desirable."
"Looks like the Bank is now being run from Whitehall," adds Charles Pretzlik for the Financial Times. "Can the governor stay in these circumstances? Does he want to? Surely this is one U-turn too many...unless the governor knows something new that we don't."
Ben Bernanke always said he would slash interest rates to forestall recession. He's not known as Helicopter Ben without good reason! Now Dr.Ben has made good on his promise, and set about destroying the Dollar to prolong the Great Greenspan Inflation. Mervyn King, on the other hand, forgot what central bankers are for.
An independent Old Lady is no use at all if she won't do what she's told.
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