Monday, July 2, 2012

Some Sobering Thoughts From A Central Banker

Recently, Sir Mervyn King, Governor of the Bank of England, addressed the United Kingdom's House of Commons Treasury Committee and offered some interesting comments on the state of the economy.  Here is a link that will connect you to the meeting in its entirety:

In this posting, I'll pick out of few of the salient points of his comments followed by the point in time of his comments during the discussion in brackets.

Sir King is asked whether he believes that the economy is close to a liquidity trap, a situation where short-term nominal interest rates are zero.  In this situation, increasing money supply has no impact on either economic output or prices because, in general, increasing the money supply lowers interest rates.  Sir King does not believe that the economy is currently in a liquidity trap, however, he states that we are "not there yet" (10:10).  He believes that continued assets purchases will inject more money into the economy.  While he does not believe that the economy is in a liquidity trap, he does state that people are behaving in a "very defensive way" and that they are unwilling to invest.

It's interesting to note that, recent figures released by the Bank of England show that the broad M4 money supply contracted by nearly 4 percent in the past year to a new record low, driven largely by the banks which continue to cut back their lending to businesses as shown on this chart:

Here is a graph showing the growth/contraction in the U.K.'s M4 money supply since the Great Recession:

Here is a graph showing M3 for the Euro area, showing that the growth rate moderates quite noticeably after the Great Recession:

In contrast, here is a graph showing the steady growth in M3 for the United States:

Some economists believe that the decline in the growth of the U.K. money supply suggests that the Bank of England will likely implement yet another round of QE, even though the £325 billion worth of QE thus far has ended up being hoarded by banks and investors who are buying safe assets rather than lending as was the intention of the programs.

Sir King states that the Bank needs to supply emergency liquidity to the economy (10:12) since the impact of the ECB's liquidity boost wore off after 2 to 3 months.  In case you've forgotten, the ECB loaned half a trillion euros in three year loans (LTRO) back in February and March  Apparently, central bankers are very slow to learn from what has not worked in the past and insist on prolonging their experiments.  Perhaps this really is a sign of desperation.

The IMF has recommended that the Bank of England cut interest rates further.  Here is a graph showing the benchmark interest rate for the U.K. since 1971 showing that current rates (sitting at 0.5 percent) are well below previous 40 year lows:

Sir King states that the Bank has rejected the notion of further reducing interest rates because this would cut the cash flow to the nation's banks by reducing the net interest margin, particularly for the nation's building societies, financial institutions that are owned by their members (i.e. credit unions) and offer banking services, particularly mortgages.  He does not that interest rates would be cut if necessary (10:18) however, he notes that further asset purchases (quantitive easing) would have a far greater impact on the economy than a 0.25 or 0.50 percent interest rate cut.  One member of the Treasury Committee noted that a cut in interest rates would benefit mortgage holders by putting more money in their pockets; Sir King argued that such a cut would negatively impact bank profit margins and would affect other lenders by squeezing them out of the market.

Mervyn King notes that, over the last six weeks, he has seen Europe's economic situation deteriorate markedly (10:21).  The problems facing the United Kingdom's banking sector (10:27) stems from their exposure to the periphery of the Euro area, making the future prospect of lending more risky.  If things do continue to deteriorate in the Euro area, it would put a "dent" in the capital position of U.K. banks, making it riskier for the Bank of England to lend to banks.

Sir King notes that there is "no simple solution" to resolve the Euro area problem.  "Enormous challenges" lie ahead and he is "pessimistic and particularly concerned" since, from his perspective, the Euro area problems have been "pushed down the road" for the last two years.  The worsening problems in Asia, the world's emerging markets and the United States have left Sir King stating that we are "not in a comfortable position".

I'd say that's the understatement of the year!

In closing, I'd like to skip ahead to the 11:03 mark in the video.  Here, Sir King is asked how long it will be before "we get back to where we ought to be".  He notes that when the crisis began in 2007 - 2008, "...most people... did not believe that we would be in the middle of it five years later".  He notes that he has always felt we are "...not half way through it" as the problem "expands over time".  He also states that there is "enormous uncertainty out there".

I guess he's just putting into words what we've all been suspecting all along.  It is particularly concerning when one of the world's most influential central bankers tells us that we are not halfway through the economic problems that presented themselves during the Great Recession and that the problems are, and will, continue to expand.  Sadly, we're reliant on the ilk of Sir King and his fellow central bankers for a solution.  Unfortunately, the world's central banks seem to have backed themselves into a near-zero interest rate corner from which there is no clear escape.


  1. That's "Sir Mervyn" to you, guv! But that apart, this is very worrying. We do live in interesting times :-)

  2. Yes, do pardon my familiarity with the man.

    1. lol...don't apologize, it's not familiar at all; his first name is Mervyn and his last name is King (he was knighted presumably). Knights are addressed as "Sir Mervyn" not "Sir King". This is all ancient and silly stuff, but it will sound as incorrect to a Brit as if I called a man, Miss Smith. Excellent blog, btw.

  3. @PJ, Solid report on an interesting topic, as usual. I take issue with one comment: "Sadly, we're reliant on the ilk of Sir King and his fellow central bankers for a solution." I think we aren't reliant on them, which is good because they can't deliver. No magic policies are going to quickly heal us of this debt hangover, only time will help. Spending will eventually loosen up, and we'll enter a steady, and hopefully sober, growth portion of the business cycle. Unless the business cycle has been quashed, that is.