The Libor scandal has given us a new perspective on Sir Mervyn King. The governor has become The Guv’nor, the genteel grandee of the Square Mile as a bit of East End muscle.
In telling Marcus Agius, the Barclays chairman, Bob Diamond had to go, we saw not so much the governor’s eyebrows as the governor’s headbutt.
Maybe he had to be blunt because, judging from Agius’s circumlocutions in front of the Commons Treasury committee, he wanted to be sure it had sunk in.
This is not, of course, the first time the authorities have ordered the banks to do things they would have preferred not to. Fred Goodwin, the former RBS chief executive, memorably described being forced to take a huge chunk of taxpayer-provided capital as a “drive-by shooting”.
The banks are having the Vickers Commission proposals imposed upon them, which will ring-fence their commercial and investment banking operations.
The point is that the banks are being told to do a lot. There can be no greater official interference in the business of a private company than telling its chairman to sack his chief executive. This is not to say King was wrong, far from it, but it gave the lie to the idea of the banks being free agents.
This, for me, raises a bigger question. Why, if the authorities can order the banks to do so much, can the Bank and the Treasury not just tell them to lend? The Bank’s role is as much to ensure an adequate flow of credit into the economy as it is to prevent that flow from being excessive. Why is it failing in that task?
On Friday we had details of the latest official wheeze, “funding for lending”, unveiled at the Mansion House last month. Under it, the banks will be offered official funding at below market rates, probably at about 0.75%, in exchange for maintaining or increasing lending.
It is the latest in a long line of initiatives, including the Project Merlin deal with the banks on small business lending and the credit easing plan unveiled by George Osborne at last year’s Tory conference.
There is nothing wrong with funding for lending in principle, which has the potential to get £80 billion more into the economy. But the banks are required only to “maintain” their lending to get the cheap funding, and there is no guarantee they will pass the low funding costs on to customers. Business groups have welcomed it, but are sceptical about whether it will transform small firm or consumer lending. And I cannot help thinking that it and the other schemes are a roundabout way of proceeding.
If there is genuinely no appetite for borrowing, as the banks often say, even cheap funding will make little difference. If loans are only viable because they are made on the back of such subsidised funding, then maybe they should not be made at all.
But if, on the other hand, the banks are simply holding back, as I believe in large part they are, then a bit of the muscle directed at Agius over Bob Diamond ought to be enough to unleash more lending, rather than dancing around the problem with fancy and complex schemes.
The banks will say, when they are not blaming lack of demand for loans, that regulators are to blame for a credit famine that has seen small business lending fall almost continuously since early 2009.
Andy Haldane, the Bank’s executive director for financial stability, responded in The Times, saying it is not a bunch of “risk nutters” stifling the recovery. The Bank’s financial policy committee recently issued guidance that liquid assets can be used to support credit and growth, “not stuffed under banks’ mattresses”.
All well and good, but if the banks are under the impression that they are under regulatory pressure to de-risk themselves rather than lend, which they are, credit availability will continue to be a problem.
What does the Bank do when faced with a weak economy? It prints money. This month’s announcement of a further £50 billion of quantitative easing (QE) will take the total to £375 billion, analysts predicting an eventual £500 billion of asset purchases, mainly gilts (UK government bonds).
My position on QE is straightforward. I had no problem with the first round of £200 billion, launched in March 2009. The economy was falling off a cliff and the kitchen sink was needed. Stopping the slide was essential, and there was a genuine fear that prolonged deflation – falling prices – was a serious risk.
The second round, launched last October, was different. Growth had slowed but there was no collapse. Though inflation is now falling, deflation did not come into it. What should have been an emergency tool became an everyday instrument.
The Bank would say QE proved itself in 2009, boosting both growth and inflation. But we only have its assessment to rely on, and it is not an independent witness. I am not aware of a rigorous independent investigation of QE
I am not the only one concerned about the use of QE in these circumstances. Pensioners’ groups point out that, by depressing bond yields it has hit annuity rates, as well as widening pension fund deficits. There is something inherently uncomfortable about a central bank buying so much of its government’s own debt.
Such discomfort has reached the Bank for International Settlements, the central bankers’ bank. Ultra low interest rates and large-scale asset purchase programmes such as QE run serious risks, the BIS said in its annual report.
They could, paradoxically, damage the banking system, distort financial markets and put off necessary tough decisions, it warned. They have boosted commodity prices worldwide, pushing up inflation.
And, it added: “Failing to appreciate the limits of monetary policy can lead to central banks being overburdened, with potentially serious adverse consequences. Prolonged and aggressive monetary accommodation has side effects that may delay the return to a self-sustaining recovery and may create risks for financial and price stability globally.”
We should listen to the BIS. It was prescient in warning of the strains that resulted in the global financial crisis. It is worried that central banks are getting hooked on the drug of printing money.
There is also the question of what QE is for. To be fair to King, from his first BBC interview on the policy in March 2009, he has insisted it was not a scheme to boost banking lending, but pump up money supply directly. That is fine, but over a prolonged period the money supply measure the Bank follows, M4, will not rise much if there is no increase in bank lending.
QE, like the other schemes, is a roundabout and potentially risky way of going about things. An economy starved of credit self-evidently needs more credit. The governor should use his newly-discovered muscle to get the banks to lend. And he should not take no for an answer.
My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
This post originally appeared at David Smith’s EconomicsUK and is posted with permission.