The Quintet Screwing up Europe #2

August 5, 2012

Part 2 of the PIIGSty analysis based on Matthew Feeney’s article of continues with an insight into the Bank of England Governor Mervyn King.

2. Sir Mervyn King Governor of the Bank of England (BoE)

The British have historically enjoyed their splendid isolation from European entanglements. The Euro-crisis is no exception. With UK growth forecasts set to be slashed, the UK is now staring directly into a double (or even triple) dip recession. The key player here is Bank of England Governor Sir. Mervyn King. A skilled technocrat,  King has – on paper –  a purely independent economic job. In reality, King’s job is infused with politics. Despite what 10 Downing Street tends to say, as recipient of 50% of UK trade, Europe remains a major worry for King.

The job of BoE governor has been bolstered substantially since the New Labour government effectively privatised the bank in 1997 jettisoning it from from the reach of greasy fingered MPs. Not only does the BoE control monetary policy – it has recently supplemented its role as chief banking supervisor under the Tory-Liberal Democrat government’s plans to ‘get tough’ on the unpopular banking sector. King often has his finger on the populist pulse. His desire to see a full split between bank investment and high street activities as well as greater competition between banks is right from the street smart political handbook. King has is in good company with this view. The 2010-11 Independent Commission on Banking (ICB or ‘Vickers’ Commission) under BoE Chief Economist Sir John Vickers, recommended this separation, to remove the ‘casino’ speculative one-upmanship of modern British banks. This was undermined significantly by the softer 2012 UK Treasury white paper which featured watered down Vickers proposals. Again, politics prevail over smart economics – meaning the government (again) wins over the BoE.

Monetary independence meant keeping the pound, allowing the BoE to print money (quantitative easing) as a tool to stimulate the economy. This hasn’t exactly been a roaring success  – production is stagnant, inflation is gradually increasing and the economy continues to shrink and expand in a haphazard wave. Critics lament King’s use of ‘fiscal activism’ which only shocks the spluttering economic engine rather than seeks to get the real tools out and fix anything.

Further measures to stimulate growth seem inevitable.  With another £50bn likely toward the end of 2012, this brings the total pumped in by the BoE to £425bn – to possibly over £500bn in 2013.

Quantitative Easing

Quantitative easing (QE – aka printing money or ‘asset purchase programme’ in British speak) is an unproven and expensive medicine – buts its pretty much the only course any globalised industrial economy can realistically take (For a PIIGSty explanation on QE – see here and here). No one really can know if the patient improved because the fever broke naturally or if the medicine has cut the suffering short. Sure, QE helps finance the deficit by flooding the economy with pounds to spur growth and demand (and preserving current demand) without inflicting the full pain of austerity on the (voting) public. Although austerity or ‘necessary deficit reduction’ is unavoidable, King’s actions mean the Tory led government can  avoid the tougher actions forced down the throats of the PIIGS by the ECB-EU-IMF troika. Hence, QE translates into funding the deficit by any other means.

This means the BoE under King effectively causes inflation, to force growth of a sustainable level (2-3%) to ensure the actual pain is dissipated by growth. Seems like a handy solution? Nope – QE has downsides and as growth forecasts are slashed, the UK cant avoid the facts. Aside from being more a delaying mechanism for inducing painful but necessary long term reform of the economy by avoiding inducing tax rises and spending cuts in the hope that recovery will be swift and make these reforms unnecessary, QE risks devaluing the pound (which helps British exporters) and escalating inflation – two reasons not many would relish Mervyn King’s job.

King as Puppet-master

The British public (reasonably fairly) see King as a puppet master pulling the strings to keep profligate British banks afloat after years of making a balls of things (never mind the inconvenient truth that Northern Rock is set to make an £11bn+ profit over 10-15 years from the original government investment of £37bn in 2007. Of course that has nothing to do with the independent BoE but it is worth noting.) Another factor is that stimulus through a major public works/infrastructure project would be a more bog standard (and potentially far more successful) Keynesian option. A second option would be a direct fixed ‘free money’ to each citizen but this would be a behemoth to administer.

King isn’t afraid of strong statements. In relation to American support for EU political union, he brusquely retorted “Some of our American colleagues take the view it’s easy to solve the Europe crisis. Too many people assume Europe is one country, but we’re not one country, we’re several countries.”

King’s reputation has taken a knock recently with the LIBOR (London Inter-bank Offered Interest Rate) – a rate set in London by 16 key banks acting in consortium – in a scandal where Barclays bank under CEO Bob Diamond was found illegally manipulating the rate over a 4 year period between 2005 and 2009.  This scandal has tainted the obvious successor to Mervyn King, Deputy Governor  Paul Tucker – as King’s chummy relationship with Diamond turned destructive.

Feeney sums King’s role up, saying “Although the British government has embarked on a so-called austerity program, the fact is that there has only been a decrease against projected spending while nominal spending continues to increase. It is only thanks to the inflation created by the Bank of England that Britain is enjoying modest real terms cuts of what will probably be between 3 to 4 percent over the next five years.”  A fair enough synopsis. With growth collapsing – there will be trouble ahead and political pressure on the BoE will be enormous (independence be damned!) King’s action over the next few months may have a huge impact on the EU economy thanks to the size of its British component.