Posts Tagged ‘mervyn king’


There once was a king in Sicily called Dionysus. He had a courtier called Damocles who, in his efforts to flatter his King, told his liege how fortunate he was. To teach the obsequious inferior a lesson, Dionysus offered to swap places. There was a catch, however; above Damocles, sitting on his newly acquired throne, there hovered a sharp sword dangling by a horse’s hair, and arranged that way by Dionysus. The fear that the sword might finally fall, severing poor old Damocles’ arteries, proved too much for the imposter on the throne, who eventually begged his lord to swap back.

That’s the trouble with getting gold and riches; sometimes such ownership comes with a burden that is too high to bear. And that brings us to the subject of the UK housing market, the Bank of England, and a kind of monetary equivalent of a sword, dangling by the fiscal equivalent of a horse’s hair over the UK housing market’s equivalent of its genitalia.

You may have noticed that interest rates are quite low at the moment; lower in fact than a very low lower ground floor, which is good news for those with debts.

Suppose though that rates rise. For those who can easily pay their way that may not matter, but for those who can only just cover the interest on their mortgages out of current income, this may matter rather a lot.

“So what?” You might say.”It is time people started to learn how to manage their own finances. If you can only just afford a mortgage when rates at are at a record low, then you shouldn’t be getting yourself a mortgage at all.” It is just that in the UK, groupthink says ‘house prices always go up’, the wisdom of our elders says ‘always get the biggest possible mortgage you can possibly afford’, and George Osborne, with a wink to the wise, and a scheme he calls Help to Buy, has said: “Look, that horse’s hair that holds up house prices will never break.”

The mix of panic over the prospect of missing out on rising house prices, fear over never being able to jump on the housing ladder, and greed over the prospect of making a fortune via the magic of leverage and the guarantee that house prices always returns a profit, makes a heavy cocktail and one that is hard to resist.

The snag is that it turns out that around 18 per cent of secured loans are to households with less than £200 a month to spare after housing costs and other items of essential expenditure.

“If interest rates rise 1 per cent,” said the Bank of England in its latest Financial Stability Report, “households accounting for 9 per cent of mortgage debt would need to take some kind of action — such as cut essential spending, earn more income (for example, by working longer hours), or change mortgage — in order to afford their debt payments if interest rates rise.”

“If interest rates rise by 2 per cent,” suggested the bank, ditto, except that that it will be households accounting for 20 per cent of mortgage debt who will be so cursed.

Again, you might say: “So what? Get another job, worker longer hours, get on your bike.” But when there is unemployment, it is not so easy. Besides if we suddenly see a rush of people, accounting for 20 per cent of mortgage debt, suddenly asking for overtime, there probably won’t be enough to go around.

And that, as they say, is why a certain sword, not unlike the one Dionysus had arranged, dangles by a horse’s hair over the UK housing market.

But this story has another edge to it. “A study by the FSA,” said the Bank of England, “found that 5 to 8 per cent of UK mortgages by value were subject to forbearance in 2012, which was broadly unchanged from 2011.”

In the UK, chastened banks, many of whom are partially owned (via the government) by the taxpayer, don’t like the idea of repossessing properties. Then there is the issue of low interest rates. When they are that low, if a mortgagee gets behind with payments, why not give them more time, or so the bank might reason.

In the US it is not like that. In the US banks are more ruthless in their approach to repossessing property, but there is a good reason for that. In the UK, if a mortgage holder’s home is repossessed and it is worth less than the mortgage, it is up to the mortgagee to pay the difference. In the US, it is the bank’s responsibility.

So, US banks are more ruthless, but the consequences of negative equity are not quite as dire for US households.

So, will it happen? Will this latter day sword fall? Will the horse’s hair split? Mervyn King reckons UK interest rates won’t rise for some time. But just remember that the US economy and that of the UK are at different stages in their respective economic cycles. If the Fed, let’s call it Dionysus, increases rates, and the Bank of England (Damocles) doesn’t, there is a risk that sterling may crash. To avoid this, Damocles may have no choice to but to up rates to, as it were, cut the very horse’s hair he depends upon.

© Investment & Business News 2013

It is not often that we get a chance to test theories, at least not when it comes to the economy. But we have such a chance right now, and it relates to China, and whether or not China is experiencing its own credit crunch, or something altogether less serious.

Critics of Mervyn King and Ben Bernanke said that they misread things before the crisis of 2007/08 erupted. These critics say that during the build-up of the credit bubble, central banks should have hit the brakes, and upped interest rates. In short, like the very best party pooper, take away the punch bowl just as things start to get going.

Right now, in China, it appears that the central bank – presumably under instructions from the government – has taken away the punch bowl. The markets don’t like it, but then maybe on this occasion that is how it should be.

The interbank rate in China – that is the interest rates at which banks lend to each other –has soared. Déjà vu say those who recall what it was like in 2007 and 2008 in the West, when the words credit and crunch first started to appear in the same sentence.

It is just that some say China is not at that stage yet. Sure, signs of a credit bubble are clear, but it is not like the UK and the US during the height of their bubble – not yet.

The People’s Bank of China, or PBC, published a note last week saying: “Liquidity for the banking system as a whole remains at a reasonable level.” And since the PBC tends to follows the dictates of government, it is generally assumed that is the view of China’s government too.

China’s State Council recently stated: “We must promote financial reform in an orderly way to better serve economic restructuring.” Again, this suggests the government wants to rein back all that borrowing.

There is one major difference between China’s credit bubble and the one we experienced in the West. In the economy behind the Great Wall, it is local government and state owned companies that are hitting the credit button.

What China needs is for less money to be thrown at investment projects and more to trickle down into wages. In the case of China, squeezing credit may boost consumer spending – in the long run at least. It is all part of the process of adjustment China must go through as it shifts from investment to consumer led growth.

China’s government appears to understand this.

Interest rates are going up – at least that’s the way it looks. They are going to go up in the US, as the Fed has suggested, and they appear to be rising in China, as the government wants.

In the case of the US, if rates rise it will be because of good news on the US economy. If they rise in China, it is because the government is trying to learn from the lessons of Alan Greenspan and Ben Bernanke.

© Investment & Business News 2013

In recent weeks, the US Federal Reserve has dropped hints about the imminent end of its quantitative easing programme. At the same time, the Bank of Japan has announced a new, highly expansionary monetary policy, and even at the Bank of England many members, including its Governor Mervyn King, have voted for additional QE for much of this year.

This has created contradictory forces: speculation about the end of QE from the US, but expectations of more in the UK and Japan.

The US economy, however, is more important to the global economy than that of the UK and Japan combined, and in recent weeks markets have allowed their fears about the possible end of QE in the US to outweigh their hopes for more QE from other parts of the world.

In theory QE has the effect of pushing up the price of certain bonds, which in turn makes other assets look relatively cheap. Many argue that QE is the main reason for recent rises in share prices, and that it is therefore creating a bubble which will eventually burst.

On the other hand if the markets reason that QE will lead to inflation, they are likely to demand higher yields on bonds which will force their price downwards, so it is not clear that QE will always lead to higher bond prices. As for equities, it is worth noting that while valuations in equities to earnings may be marginally higher than long term averages, the ratio is not at levels that would normally be considered characteristic of a bubble.

So the jury is out on the overall effect of QE on bond prices and, more specifically, on equities.

However in recent weeks, the price on UK ten year government bonds has risen above the price of the US equivalent, suggesting that markets are selling US bonds in anticipation of the end of QE. They are not selling UK bonds in such large quantities because of hopes that the Bank of England may yet announce more QE. This may lend evidence to the idea that QE does indeed boost bond prices.

But the question remains: what will happen when QE finally comes to an end, whether this is in 2013, 2014, 2015, or at a later date?

When the US Federal Reserve increased interest rates in 1994, the eventual result was the Asian crisis of 1997, the Russian crisis of 1998 and the collapse of LTCM. The US, on the other hand, was largely unscathed.

If QE in the US is coming to an end, what does that mean for the rest of the world? Read the rest of today’s articles for an answer.

The end of QE: Canada and Australia 

The end of QE and the BRICs 

Beyond the BRICs: which emerging markets are vulnerable to the end of QE? 

© Investment & Business News 2013

QE is drawing to a close; that is reason to panic. QE is set to be ramped up; that is reason to panic. That is what some say who see any news as bad news, including news that is totally contradictory.

The US is back, and the economic crisis is drawing to a close. ‘Celebrate,’ say the optimists. QE is coming to an end, ‘Celebrate,’ they say. ‘QE is set to accelerate, ‘Celebrate,’ they say. The pessimists pretty much say the opposite.

That is the nature of the markets. The news contradicts itself, the markets fall into their two camps whatever it says. They interpret everything as conforming to their pre-existing views.

Just to remind you, in the US, the Fed is dropping hints that its QE programme is drawing to a close.

In Japan, QE has been reignited, but this time in really big fashion. In the euro area, interest rates have been cut to half a per cent. In the UK, there is a feeling that once Mark Carney steps into Mervyn King’s shoes at the Bank of England, we will see a lot more QE.

So that is both more and less QE.

Bond prices have fallen. In the US the yield on US government ten year bonds has risen from 1.6 per cent at the beginning of May to 2.13 per cent by the last day of the month – that was a 14 month high, by the way.

The BIS, which is a lot like the world’s central bank, says this is a taste of things to come. In itslatest quarterly review it talked about the markets living under the spell of QE.

It says that the road will be bumpy as conditions return to normal.

But is that really a reason to fret? Over the last few years the economy has been in crisis mode and low bond yields have been a symptom of that. As we return to normal, surely bond yields will rise, and that is good.

Except, of course, who knows whether we are returning to normal, and indeed markets panic, even when times are good.

If the good times return, markets may well panic over bonds and we may yet see a crash. There is more reason to worry over emerging market bonds. So that’s ironic, impriving economy may be a reason for market turmoil.

But perhaps the fear is that bonds yields rise, even if conditions have not returned to normal. See:The Great Reset

© Investment & Business News 2013

If it had done something, it would have been a surprise. The Bank of England has chosen to leave monetary policy where it is for another month.

The news on the UK economy has been a touch better of late, with Q1 seeing 0.3 per cent growth and Purchasing Managers’ Indices for April indicating a modest pick-up from there. Besides there is one person missing from the Bank of England’s MPC at the moment and that is its governor to be. Until he joins, the committee is not likely to do much.

Poor old Mervyn King! He voted for more QE in February, March and April. One assumes he voted for it again today. But he is looking like a lame duck governor these days. Apparently, most MPC members are waiting for Mr Carney.

Or maybe not… Martin Beck, UK Economist at Capital Economics, put it this way: “We still anticipate further asset purchases later this year, with the arrival of Mr Carney potentially acting as a catalyst. But it cannot be taken for granted that he will win the day against the inertia and hawkishness of other Committee members.”

© Investment & Business News 2013

It’s two for the price of one. A new acronym, and a new (ish) idea. And QE, by the way, is so very 2012.

The thing about QE is that it is not really money printing. The Bank of England buys government bonds – not from the government – but from banks. But one day the bonds will mature, and when that happens, the effects of QE will go into reverse. Besides, there is another point. To acquire this money from the Bank of England, banks have to give up what is considered to a very safe and liquid asset – namely bonds.

Now if QE involved buying bonds at zero interest with no maturity date, directly from the government, that would be called creating money.

QE is not what they call helicopter money. It is not the equivalent of scattering money from a helicopter. It is more like scattering money from a helicopter, and sucking up certain assets from the ground at the same time.

What QE does do, is push up the price of bonds, making other assets look cheap, thereby either stopping certain assets from crashing, or indeed making them rise. So house prices or equities rise in price, and we may feel more confident and spend more, and businesses may invest more. That strategy does not work as well when the asset that rises is oil – or indeed gold.

But some say that the Bank of England needs to target its QE more precisely.

This is what happened in the US. Some QE was used to get rid of so called toxic waste from banks’ balance sheets and as a result – goes the argument – banks are in better shape. Some of it was used to buy corporate bonds, ergo – goes the argument – the US has seen a swifter recovery than the UK.

So what can the Bank of England do? Former MPC man Adam Posen wants to see it buy bonds in a kind of public bank, charged with investing into business.

Recently, Adair Turner – chairman of the FSA and one of the men who was at one point thought to be in the running for heading up the Bank of England after Mervyn King – called for what he described as overt monetary financing, or OMF. This is helicopter money, it is QE targeted at certain assets, and it is something Mervyn King is dead set against.

He said it’s not up the central bank to do such things, because then it would be engaging in fiscal policy. Rather, he says, it is up to the government. But the government wants to make cut backs. If the government spends money it is slated for being reckless. So we get £375 million of QE, and still the UK is limping along bottom.

Before we close, it may be worth reminding ourselves of words spoken by Adam Posen last year when speaking to the ‘FT’. He said: “I personally view the teeth-gnashing and garment-rending about what’s fiscal and monetary as too much drama for too little content.” He then added that the Bank of England holds “anguished religious ethics” about QE.

So maybe we need to move from QE to OMF. Or is that blasphemy?

For Lord Turner’s speech  discussing OMF, see: Debt, Money and Mephistopheles: How do we get out of this mess?

©2012 Investment and Business News.

Investment and Business News is a succinct, sometimes amusing often thought provoking and always informative email newsletter. Our readers say they look forward to receiving it, and so will you. Sign-up here

Germany’s head central banker calls it the work of the devil. Last year, Jens Weidmann, Germany’s answer to Mervyn King, told a story from ‘Faust’. A king is running out of money, and the devil disguised as fool persuades him to solve his problem by printing new money. The result was hyperinflation. And that, says Mr Weidmann, is why QE is like the work of the devil.

It is just that QE is not really money printing at all. When the Bank of England buys government bonds it is assumed that it will sell the bonds at a future date.  So if QE looks as though it is leading to inflation, the effects can be reversed.

That’s the theory.

The reality is that that QE doesn’t seem to be doing an awful lot. Sure it may have stopped the recession from becoming  worse, but given the sheer size of this measure – £375 billion in the UK so far – it seems remarkable how low inflation is, and how tiny growth is.

The snag is that debt is the key to the banking system we have these days.  When we borrow money from a bank, we spend it and the recipient of our money pays it into a bank. So when a bank lends money, the money it lends reverberates around the economy. In this way, by their lending, banks create money.

But if we all suddenly decide to borrow less, or if banks decide they can’t afford to lend so much, the broad money supply may well contract faster than an anaconda on speed. QE has had the effect of mitigating this contraction. But it certainly has not had the effect of creating massive growth in the broad money supply.

Perhaps then it is time to really engage in money printing and hand the resulting money out across the land. Milton Friedman pretty much suggested such an idea once. He said that in times of a depression if all else fails, why not scatter money from a helicopter. Before he was chairman of the Fed, Ben Bernanke once said he thought Friedman may have been right.

But that’s where the devil comes in: wouldn’t money printing in this way just create inflation?

For that matter, this whole idea of running a large government deficit is also seen as pretty much akin to devil worship – by some.

Well, maybe. But explain why it is that in times of war – World Wars 1 and 2 for example – governments suddenly found that they could print money to fund the war effort, and could run-up huge deficits. And why is it that the post war periods were not followed by inflation, rather than economic boom, which was often the result. Sure, Germany had hyperinflation, but that was down to the Treaty of Versailles. The UK limped along in the 1920s, but that was largely because adherence to a gold standard removed the Bank of England’s ability to create money. The argument continues to say that periods in history when governments ran surpluses were invariably followed by economic depression. See: conspiracy theories, free lunches, and the theory that banks are destroying wealth .

Some go further – they say the insistence that governments run prudent fiscal policy is a conspiracy, forced upon us by banks who are trying to protect their nice little way of making money. Is the conspiracy theory right? Probably not. But the point is that there is an alternative idea to the established view. The idea suggests that instead of the money supply growing via debt created by banks, the government boosts the money supply by creating new money, and banks’ ability to create credit is then curtailed by legalisation.

The argument may or may not be right. But we may be getting an opportunity to test the theory soon.

As US politicians refuse to compromise, and Republicans and Democrats blame each other for the US’s woes, Obama may have come up with a solution.

Under US law the US government cannot print money – that job is entrusted to The Fed. Except, thanks to legislation from 12 years ago, the government is allowed to create platinum coins. The legislation was designed simply to enable the US government to create commemorative coins.

So why not make a one trillion dollar platinum coin, deposit it with the Fed, and then withdraw money against it, thereby abolishing the US government’s need to have approval from Congress before raising its fiscal debt? Friedman and Bernanke will get their money drop, and the conspiracy theorists will have their chance to put their theories to the test.

But such a measure, unlike QE, can’t be reversed. Critics say such a move really would create inflation.

Paul Krugman, the Nobel Laureate who pens a highly influential blog for the ‘New York Times’, has suggested he is in favour of the idea. But it seems he really sees this as kind of a warning shot. He doesn’t really want to see a one trillion dollar coin; rather he reckons the threat of taking such an action will be enough to ensure that the Republicans compromise with Obama.

Perhaps what we can say is that that we are seeing a very interesting development in the story of our times.

©2012 Investment and Business News.

Investment and Business News is a succinct, sometimes amusing often thought provoking and always informative email newsletter. Our readers say they look forward to receiving it, and so will you. Sign-up here