Tuesday, 5 April 2011
Bank of England's hidden agenda guts all savers
There can now be no doubt that the Bank of England (BoE) has abandoned all pretence of controlling inflation through the interest rate mechanism, once considered its core function since its independence over 10 years ago. And like America's Federal Reserve Bank, it is now trying to serve two masters, despite the Nazarene's missive on such futility. On the one hand the BoE still professes to want to curb inflation but on the other it keeps interest rates at historically low levels ostensibly to help the nascent recovery and so bring down unemployment. But in pursuing the first objective through ludicrously low interest rates it merely risks a re-run of the credit mess following the dot.com bust and 9/11 which created crassly low interest rates and so unleashed a spending binge fueled by cheap, lax credit. The BoE's anti-inflationary policy has failed lamentably, though in fairness partly because of circumstances beyond its control. Its monetary policy committee is required to achieve a target of 2% inflation. The latest retail price index for February 2011 shows an annual rise of 5.5% while the Government's own preferred benchmark, the consumer price index, has soared by 4.4% over the same period. But is the BoE's low interest rate policy to encourage recovery a smokescreen for a more cynical ploy that will have unprecedented adverse impacts on pensioners and all those who saved hard for their old age? The numbers suggest that it is. "Banking establishments are more dangerous than standing armies," commented Thomas Jefferson. How right he was but in ways, perhaps, that even he did not realise. Such an ostensibly august institution like the BoE was, in fact, born out of the perceived necessity to finance war. With the power to create credit up to 12 times the cash deposits placed with it, the BoE used debt to finance the British Government's wars throughout the 18th century until the national debt soared to over 200% of gross domestic product (GDP) at the end of the Napoleonic wars in 1815. Such a debt level was not seen again until World War 2, while today it stands at 60% of GDP, a level not seen since the late 1960s. Debt, it seems, is the Devil's chaplain. Clearly, debt has some advantages. It can, for example, facilitate economic growth and allow consumers to have their desires fulfilled now rather than years down the line when they have saved enough to buy goods outright. The flip side on runaway debt levels, however, has disastrous potential. It is the BoE's hope, and probably the Government's, that by keeping interest rates absurdly low it will encourage business investment and private consumer spending. But will it? Compared with collectivist economies, capitalism's one great disadvantage is that the decisions to invest and the decisions to spend are taken by two different groups. Capitalist economies can encourage investment through government incentives like lower taxes and low interest rates, but it cannot force the public to spend more as as result. The risks that the current BoE and Government's policy may fail in their pump-priming objective are high because the huge debt levels taken on by government now mean public spending must be drastically cut and many workers fear for their jobs and when fear stalks the land the public's propensity to save rises. Business will not invest much more if they see a public spending less. Meanwhile, the dangerously low interest rate policy has other recovery impediments. It takes four to five building society investors to support one mortgage borrower. While borrowers benefit from low interest rates and so may be inclined to spend more, the savers supporting them all suffer real falls in their disposable incomes because inflation and tax now far exceed investors' derisory returns of 3% or less. It is, perhaps, the BoE's greatest, most shameful transfer of wealth from the frugal to borrowers. But there is seemingly worse behaviour afoot. The UK government's debt for 2011 is estimated at £932 billion, or 60% of GDP. Its spending on state pensions will be £117 billion this year and while that may be indexed to the retail price index for annual rises it is clear that by keeping interest rates low the BoE will make it much easier for the government to repay its huge debts through depreciated money. At 5% inflation the Government's national debt would be cut by £51 billion in real terms after one year. The extra costs of the state pension in money terms would be only £5.85 billion over the same period. The case for continuing the low interest rate policy is unsustainable and grossly iniquitous on those least able to defend themselves -- the pensioners and small savers. If rates were allowed to rise to their long-term levels of 5% or 6% it would encourage the retired, in particular, to spend more and these far outnumber mortgagees who would be faced with spending less. Higher rates would also head off the reckless spending by investment banks, hedge funds and other pinstripe bookies which dreamt up new investment packages like collateralized debt obligations and credit default swaps, which together with derisory interest rates largely caused the worst credit implosion since the 1930s. There is, however, another lesson the British Government, in particular, must learn. The Chinese sage, Sun Tzu, remarked in 400 BC : "Where the army is prices are high. When prices rise the wealth of the people is exhausted." With Afghanistan costing the British tax payers well over £6 billion a year, Libya at least £3 million a day, with the potential for far more, and military spending commitments like two unnecessary aircraft carriers and the Trident submarine replacement cost looming on the horizon, such events can only be inflationary. When America grappled with the rocketing inflationary consequences of the Vietnam war in the 1970s it led to Federal fund rates hitting 20% and soaring unemployment to get the situation back under control. The message from the Fed was that unemployment had to take a back seat to fighting inflation. It is a lesson that thus far seems to have been lost on the BoE. Now is the time to raise rates significantly before it is too late.