The Ignis Rates CBOY Committee has awarded Mervyn King their central banker of the year award in 2008, 2009, 2010 and we have once again unanimously voted to award him the title for the fourth year in succession for 2011. The determining criteria for this award remain the same; the successful candidate must demonstrate clear pragmatism, outstanding intellect and unswerving devotion to the pure principles of central bank theory.
The citation for Mr King’s 2011 award has been taken from his own speech to the Institute of Directors at St George’s Hall in Liverpool on October 18th; “from the beginning of the crisis there has been a reluctance by governments to face up to the underlying solvency problems generated by the apparent unending trade deficits with no mechanism, whether flexible exchange rates or some other means, for correcting these disequilibria. Those solvency problems have shown up on country and bank balance sheets. The initial reaction has always been to provide liquidity; through central bank or an extension of official lending by governments. Providing liquidity to buy time to devise and put in place a coherent response to the underlying problem can be not only valuable but necessary. But liquidity can never be an answer in itself. And if the time bought is not used then the size of the debt problem becomes larger and the cost is gradually transferred from private sector creditors to taxpayers.
The main impediment to the strategy of rebalancing our economy is markedly slower growth in our major export markets, especially in the rest of Europe. This is why we are treading a fine line between stimulus to demand in the short run, and a rebalancing away from private and public consumption towards exports and import substitution in the longer run. Without monetary stimulus, low interest rates and large asset purchases, there is a risk that growth would stall and inflation fall below our symmetric 2% target. But easy monetary policy, by bringing forward spending from the future to the present, means that the ultimate adjustment of borrowing and spending will be even greater. That is our dilemma and that of other deficit countries. The best way to escape this dilemma would be higher spending by surplus countries, to make possible rebalancing by the deficit countries, and supply side reforms in the deficit countries, to raise expected future incomes and to ease the burden of debt repayments. Each country can put itself in a position to rebalance, as we have done in the UK. But in the absence of rebalancing, globally and especially in the €uro area, we could be facing a recovery that is not merely reluctant but recalcitrant”.
Sir Mervyn’s wise words shows how policy is working in harmony with fiscal policy, but also emphasises the seemingly intractable problems in Europe and explains why massive liquidity from a central bank is a temporary panacea rather than a solution. This argument neatly skewers those who would anoint the new ECB President as central banker of the year. The miniscule time gained is not enough to reach the political union that is necessary to bind together this dysfunctional group into permanent. Mario Draghi is correct in describing the fiscal compact as the first step toward fiscal union but as Confucius said “a journey of a thousand miles begins with a single step” and it will take hundreds of thousands of more steps before this dream becomes reality, something we doubt.
More importantly, we believe that Senior Draghi’s task will be complicated by the perennial bailouts of Greece and demands of other countries for similar debt relief. The new President has already compromised several cherished principles of pure central bank theory and will undoubtedly compromise more during 2012 as French politics add further stresses to an already impossible task.
The non-voting members of the awards committee provided very vocal support for Fed Chairman Ben Bernanke citing prediction that if economic conditions remained weak the central bank was likely to maintain its record low interest rates until the middle of 2013 (subsequently he extended this presumption until end 2014), which in turn was followed by Operation Twist, which switched $400bn of short dated treasuries into medium and longer dated treasuries following the textbook prescription for evading the liquidity trap. However, he just failed to achieve top spot because of the parsimonious scale of his unconventional monetary policy and continued verbal support fiscal easing. The $600bn QE2 program and the $400bn Operation Twist are small versus the $14tr US economy.
Nevertheless, Ben Bernanke is one of the early contenders for the 2012 award. He remains committed to further QE and while current economic data is too strong to allow additional stimulus, we believe that he will react quickly to any signs of weakness. However, this will not unfortunately be more traditional treasury purchases and is more likely to be additional credit easing in the form of MBS purchases, blurring the lines between fiscal and monetary policy.
Inevitably, Sir Mervyn King is also a leading contender for CBOY having delivered another £50bn stimulus for the economy and largely dismissing the exaggerated increases in the purchasing managers’ indices. However, the operations department has succumbed to intense lobbying and shortened the buckets in which the central bank will carry out these purchases. There are understandable reasons why this has been done, but they contravene the core belief of quantitative easing to flatten the term structure of interest rates in order to encourage investors’ animal spirits. We believe that this black mark is temporary and that the Governor is likely to redeem his reputation by carrying forward the MPC to an additional £50bn in May.
Chief Economist, Co-Fund Manager
Feb 13, 2012 at 12:44pm