Between the hawks and the doves of the MPC, there is no comfortable middle ground.
Imagine for a moment that you have agreed to serve on the BoE’s MPC. In the chair is your paymaster, Mervyn King the Governor, with his doves; opposite him is Andrew Sentance and the hawks who want to raise interest rates now in the light of the UK’s 5.5% inflation. (That’s based on the EU’s CPI inflation, historically about half the UK’s RPI inflation, which is itself roughly half the actual inflation as experienced by normal human beings like you and me.)
And sitting on the MPC, somewhere in Mid-Atlantic, is Mr. Andrew Posen, a yank and an admirer of Helicopter Ben Bernanke, who wants another £50.0 billion of UK QE, spread like confetti at Gordon Brown’s belated marriage to Prudence. The Governor rules the roost, however, as he should do in his own parlour, with the help of some Jobsworths on the BoE’s payroll.
Mervyn’s doves’ position is as follows: raising interest rates in the UK is going to have no effect on foreign floods, droughts, earthquakes, volcanoes and revolutions – it was Lord Melbourne who opined to Queen Victoria “Abroad is horrid!” – that are sending the price of food, clothing and energy into the stratosphere. Besides, the one component of the UK economy that is working brilliantly is the private sector, with exports of manufactures and services doing nicely, thank you, courtesy of Mervyn’s 2009 discretely-executed decision to let Sterling devalue by a massive 25%, something the PIGS trapped in the €uro-thingie can only dream about.
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And to raise interest rates when households are struggling in the most massive squeeze in living memory will cause the housing market to fall further, and that will further weaken the banks’ already shaky balance sheets. So rates are on hold, while Mervyn writes once-a-month to his new friend the Chancellor on Saving-Face-book, our new website, saying why he can see across the Valley of Inflation and there’s nothing to worry about. He hopes.
The hawks, on the other hand, know only too well that they’re meant to be on this committee to keep inflation below 2%, as measured by the CPI, which under-scores real inflation by a factor of 2, 3 or even 4 times. They argue that interest rates must rise now, as the BoE is clearly already behind the inflationary curve, which is a global phenomenon being driven by the BRICs and emerging markets and their insatiable demand for energy, food and precious metals, and they account for half the world’s 7.0 billion population.
A rise in UK interest rates, however, would make UK exports less competitive, cause untold misery in the housing market and devastate fragile family budgets; and the banks’ shaky balance sheets. Raising interest rates would, however, cause Sterling to rise and reduce the cost of all those horrid things from abroad, like food, clothing and energy, and Russians buying up Mayfair.
Well, it’s a tricky call, as both sides have a point, or several good points. On balance, I am with Mervyn and the doves for now, but am likely to swing behind the hawks as soon as the recovery gathers any discernible traction. And that depends on the US rather than the UK, as ever. It makes sense for Mervyn and his doves to wait and see how Uncle Sam performs under the questionable economics of Helicopter Ben’s printing presses, but the evidence is conflicting: 2010 Q4 US GDP was revised upwards to 3.1%, but stubborn unemployment is continuing, as is the continuing fall in the US housing market.
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America is not out of the woods yet, and if and when it is, then the rising Federal Deficit and the fact that Total Debt (defined as Federal and private debt, but not municipal and state debt) is rising through 400% of GDP, with the Federal Deficit at 90% of GDP, which will have their own long-term unavoidable consequences. And Helicopter Ben has no option but to continue with his QE nonsense, until his helicopter runs out of fuel, altitude, credibility or rotor-blades.
That’s why interest rates today are the key issue in the short-term: if you believe that the way forward is more QE, then it seems pointless to those adumbrating QE to raise interest rates and their own borrowing cost. The problem, however, is that it was Alan Greenspan’s keeping US, and therefore global interest rates, far too low for far too long after the dot.com bubble burst in 2000 and after 9/11 that caused Global Crunch in the first place.
The danger now therefore is that the Fed and the BoE, and the ECB too, are setting up the conditions for future Hyper-Stagflation. And then interest rates will have to rise far further and far quicker than anyone is prepared to contemplate at the moment, thereby damaging still further the public finances with massive interest charges. Portugal, the next PIG in line for a financial steroid injection, is already discovering this to its cost, as the yield on its 10-year debt rose to over an unsustainable 8%, as S&P and Fitch knocked its rating by two notches, or practically to junk bond status.
Therein lies the danger of the current low interest rates on both sides of the pond, and at the heart of Europe too, with all the €urozone’s problems of its own creation, namely, the euro one-size-fits-all dream. It’s all a matter of timing, but time is now beginning to run out on inflation for the Central Banks, as the Anglo-American recovery has yet to really assert itself.
Still want to sit on the Committee? Better to sit on your gold!
