King has nine months left to atone for his sins

Sunday, 23 September 2012 17:59

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By George Kerevan

SIR Mervyn King is demob happy. In his first live TV interview for a decade, with Channel 4’s Jon Snow, the governor of the Bank of England was happy to criticise the coalition over banking reform, the Treasury over economic policy and Aston Villa for its football.

Sir Mervyn retires next July and clearly feels free to speak his mind (at least, as much as central bankers ever do).

On the banking reform, King said he stood by the original recommendation to government from Sir John Vickers to fix the leverage ratio of bank wholesale borrowing to core reserves at 25:1. After heavy lobbying from the banks, the government has relented and set a figure of 33:1.

The governor came as close as he could to saying that Chancellor George Osborne had been lent on. On this one, I think the governor is wrong (as I think he has been on so many things). Modern banks finance their lending by borrowing wholesale from other banks. If you restrict their wholesale borrowing, you restrict their ability to lend. Remember that the next time you want a mortgage.

At the top of the boom, inter-bank borrowing was too high, funding an asset bubble. Perhaps if King had done his job and raised interest rates, the bubble could have been avoided.

Also remember that the reason he eased monetary conditions in 2005, just as the bubble got under way, was because he was lent on by Chancellor Gordon Brown. For King to complain that the current administration buckles under pressure is the proverbial pot calling the kettle black.

What about the UK’s return to recession? King admitted that both the government and the Bank got their forecasts wrong about growth. In defence, he said: “We didn’t expect two things. One was the very large increase in energy and food prices that took place in the world economy… [and] also the crisis in the euro area.”

I’ll grant him the unexpectedness of the eurozone disaster, but the Bank’s persistent under-estimation of inflation trends is inexcusable. Sterling fell sharply after the bubble burst, thanks to King slashing interest rates. That automatically boosted import prices.

With energy-guzzling China keeping the global economy afloat after 2009, and nothing left for people to invest in save commodities, oil and food were bound to shoot up in price. Either King and his econometricians were out to lunch when it came to inflation forecasting, or – as I’ve long suspected – the Bank and George Osborne were content to let inflation rip in order to erode the debt overhang.

Asked by Jon Snow if Osborne should now abandon austerity, King was happy to offer a “get out of jail free” card. Blaming the current global slowdown, the governor said it was now appropriate to push back the target for eliminating the structural deficit. Osborne has little choice after the disastrous August Treasury borrowing figures announced yesterday. Expect a Plan B Budget next March.

Unfortunately, the one thing Snow did not ask King was if the Bank was going to follow the US Federal Reserve and the European Central Bank and initiate open-ended quantitative easing until the recession and the euro crisis go away. King still has nine months in the job to atone for his errors. He can start by pushing the monetary button and begin buying mortgage bonds to boost construction.

As for who replaces King as governor, the latest betting has Sir Fred Goodwin at 300/1. Frankly, I think those are very short odds. The bookies’ frontrunners are Paul Tucker, King’s deputy, and Lord Adair Turner, chairman of the Financial Services Authority. Turner has been making public attacks on the Bank, which may or may not suggest he is interested.

Then there is Jim O’Neill, head of Goldman Sachs Asset Management, which may be his problem. O’Neill has not denied interest, but says his choice is Sir Alex Ferguson of Manchester United. Mark Carney, head of Canada’s central bank, has been touted but denies being approached. Stephen Green, former boss of HSBC, was a favourite until his old bank was accused of money laundering.

If you fancy your chances as governor, you have until 8 October to apply.

Courtesy of George Kerevan and the Scotsman newspaper