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Dear Mervyn
September traditionally marks the start of a new political and economic season after August’s hibernation. That makes new thinking appropriate and time for the MPC to listen in a way it hasn’t up to now. The Bank is moving obstinately down the wrong path to higher interest rates and a credit squeeze. This will be applauded by the financial interests which dominate your counsels and who have already applauded your stealthy progress towards ever higher interest rates and who are currently using their platform in our ignorant media to predict confidently that rates will again go on.
We urge you to recognize that this will be disastrous for the real economy. So you should stop this progress down the dead end street, reconsider what you’re about and reverse policy to begin progressively reducing interest rates.
This is the moment to set out towards cheap money, a competitive pound and the high growth economy which goes with both.
The Bank has controlled the two basic levers of economic management, interest rates and the exchange rate influenced by them, for over ten years. The result has been the loss of over a million manufacturing jobs, a trade deficit running at 4%, an overvalued exchange rate which is the cause of both, a raging asset inflation, particularly in house prices which have rocketed higher than anywhere else. All this has been caused by a huge credit bubble and a massive failure of regulation or control in an effort to attract foreign investment, rich tax refugees, hedge funds and foreign investment in everything from national champions to football clubs to bring in the money to finance the deficit. All this has happened in a period which ends with the inflation rate only slightly higher than when it started, plus fears, hinted at by the Bank itself and enthusiastically amplified by financial commentators who know no better, that they will rise still higher to usher in a tight squeeze, which is always Finance`s medicine for the excesses it has created.
The record doesn’t inspire confidence because the banker’s traditional instincts for dearer money now operate in a very risky world. The banks have pumped up a credit bubble which has gone into asset inflation, not productive investment, unlike, say, Germany where public credit has integrated the East as a new dynamic to their powerful economy and private credit has re-equipped a powerful industrial machine.
Here Government and the Bank have neglected their duty to regulate the explosion of under-regulated bank-like institutions, the financial engineering of off balance sheet accounting (which is in fact a government policy) the bundling of debts into big investment packages and the development of a massive risk industry of hedge funds.
We are embarked on a massive game of gambles generated by a financial sector which should know that what can`t go on probably won`t. Yet the Bank which has presided over all this must be aware of the risks and must understand that the increased complexity and the spread of risk-taking makes the system potentially more unstable, more prone to crises and less manageable by the blunt instrument of ever higher interest rates. Indeed, by producing the danger of a stall, these are quite capable of producing a crisis through the knock on consequences of repossessions forcing a dash for liquidity, the collapse of debt prices and a run on funds.
A new world requires a new approach from the Bank. Until the situation can be properly regulated to reduce the risks (and we note that neither Bank nor Government have shown any interest in doing either) cheaper money is essential to keep the game going and the economy growing.
The Bank must, therefore, be prepared to reduce interest rates substantially on the first signs of trouble. The Fed, which admittedly has a broader rubric of the kind the Bank needs, has a much better record of responding to crises such as savings and loans, the collapse of Long Term Capital Management, 9/ll and now the sub prime crisis by reducing interest rates. The Bank must be equally flexible.
British problems may be better concealed because our financial community is more secretive but because it is so international it suffers from US and S.E. Asian crises and now faces the major overhanging problem that consumer demand is threatened by the huge debt overhang and production is threatened by the grossly overvalued pound. Unless growth is kept going at a higher rate than recent levels there is a very real danger of stall and wind down which can only be avoided by lower interest rates.
The crucial problem is not now inflation but overvaluation. Lack of competitiveness, which has already lost us over a million jobs in an already damaged industrial base, and production more generally, are seriously threatened unless the pound comes down.
The dollar is already coming down (which makes our lack of competitiveness worse) and US’s exporting economy is already benefiting. Yet the Bank seems determined to maintain this level of overvaluation as a weapon against inflation. We recommend that it should instead prepare the way for the inevitable by:
a) Commissioning research on the effects of the overvaluation and the prospects for exports and imports
b) Researching the effects of previous devaluations 1949,1967, 1972 and 1992 on output, growth and inflation
c) Researching the relationship between higher interest rates and the exchange rate. It would be a valuable contribution to public education and understanding if members of the MPC were to engage in public discussion about their own views on this issue.
The Bank should also research the effects of the mortgage time bomb created by the fact that people who took out mortgages at a lower rate of interest now face at the end of this period of grace a much higher rate, compounding the consequences of whatever increases the Bank had itself imposed in the interim period. This looks potentially disastrous for a large number of people.
All this points to a progressive reduction in rates, bringing the pound down to ensure that our exchange rate is not distorted by the flow of funds out of the declining dollar. Let these go into the euro. The EU always wanted the euro to look the dollar in the fact and they deserve the consequences of a kind of stupidity which we have mercifully forgotten.
Our advice, therefore, is to prepare the way for a steady reduction of interest rates. Stop talking about inflation, credit squeezes and higher rates. Opt for a one quarter percent reduction now, announcing that the policies have worked and can now be relaxed. Begin to emphasise that economic growth must be sustained and begin to talk about a more competitive exchange rate. Then embark on a steady process of reduction to take British rates below the Fed (which meets on 18 September and will probably reduce rates) and below Europe and aiming at a two and a half percentage points reduction by mid 2008.
In our view there is no other way of keeping the economy growing than cheaper money and a measure of relief on the debt burden, and if it is stalled by higher rather than lower interest rates then we are in a wind down situation of negative equity, repossessions and a threat to those funds and institutions which have invested so heavily in bundled debt. The irresponsible expansion of credit has created a very precarious balance which will respond very badly to the old recipe of discipline by higher interest rates which is all the Bank seems able to offer. This danger is made even worse by the fact that the people are already being hit by increases in fuel, food and utility prices which the Bank can compound but not control, while many are tied in to mortgage arrangements which increase their interest charges any way after an initial period of lower rates.
If the Bank fails to understand this wider picture and sees its role as an economic Torquemeda torturing for faith (in this case its own often repeated belief that interest rate increases now reduce inflation two years on which is as unprovable as Torquemeda faith that virtue leads to heaven) then it is running directly contrary to both the prescriptions of sensible economic management and the desires of the government.
CONCLUSION
Like it or not, the consequence of Bank of England independence is that it now has a more powerful role in maintaining the economy than the elected government because it manages interest rates and through them the exchange rate. It claims to be handling these in an independent, even scientific, fashion by assessing inflation prospects and then adjusting rates to bring it down to target two years on while taking no notice of the state and prospects of the real economy or what is happening in competing economies.
This has worked well for the last decade in the eyes of the financial interest which dominate Bank counsels. Yet the traditional banker’s policy of using high exchange rates to control inflation has been deeply damaging to manufacturing, UK production and the balance of trade and has ensured that growth has been lower than necessary to make up the ground lost in the eighties. Now, however, it is running into a problem that an economy boosted by unsustainable debt and characterised by inadequate regulation which has no strong industrial base is bound to stall and is now slowing. The consequences of that, if subjected to the banker’s traditional disciplines, will be disastrous.
Government may not want to recognise this but the Bank must. It can only do so by bringing rates down this month and continuing the reductions into 2008. |
