I drew attention to the 12% devaluation of the pound from $2 earlier this year to around $1.75 as that occurred. In recent weeks the pound has been hovering around $1.71-$1.75 for much of the time. Suddenly, in the last two days, it collapsed to $1.62.
Market reports ascribe the sharp fall yesterday in part to the Governor of the Bank of England’s remarks. He told us the UK banking system had been on the edge of collapse before the government offered extra share capital to three banks. This was certainly not a helpful remark, and I think it was too pessimistic a view as well. It is true the banks were strapped for cash, but the Bank of England could have solved that problem earlier by offering the large amounts of cash they subsequently made available when they were first needed. It is true they did not trust each other’s paper, and a government guarantee for a price should help resolve that. That, after all, is a prime duty of a Central bank.
It is also true that confidence in banks can be increased by persuading them to raise more capital and hold more reserves. However, the authorities unilateral decision to demand more capital for a given volume of lending, and then the decision by someone to leak details of the negotiations to Stock markets, was a move which undermined confidence further and weakened the position of the banks needlessly. The Governor also shared with us his belief that the UK will go into recession, the first time someone in an official position has made such a forecast.
The Governor – and others in authority – have to recognise how the UK is viewed by external investors. To some overseas analysts the UK is a large international financial services industry and centre married to a medium size slow growth economy which has borrowed too much. Once doubts are placed on the performance and strength of the most vibrant lead sector, financial services, which has fuelled the respectable overall growth of recent years, it puts some overseas investors off holding sterling.
My critics on this website have argued against a UK interest rate cut because they say it will lead to a fall in the pound. What we now can see is we are getting a fall in the pound with much higher interest rates than the USA, whilst the dollar with low interest rates is powering ahead. Why should this be?
Investors today would rather put their money into an economy where the authorities are using every weapon including interest rates to fight recession. They see this in the USA. They are worried that the failure of the UK authorities to take enough action to fight recession early enough will produce yet more bad debts and loan loasses in the banking system, eating up the new capital that is being provided. They worry that the very rapid debt reduction the authorities are wanting to bring about will bring further tensions within other parts of the financial system which will cause more losses. The long shadow of the Lehman collapse hangs over current proceedings. There are other non bank institutions which could cause problems ahead.
Yesterday also saw the debt Management Office in active mode, as they need to be to fund the mushrooming government deficit. They announced a £4.75 billion 2011 issue, a £1 billion 2032 issue and a £4billion 2016 issue of debt, and made up to £47.8 billion of government debt available at the Bank’s dicsount window for banks to borrow. There will be concerns about the size of public borrowing, reflecting the worries expressed recently about difficulty the Debt Management Office might start to experience at getting each issue away at the chosen price.
The National Institute has also come out with a forecast of recession next year. They sensibly re ran their forecast to see what would happen if interest rates were cut by 2.5% (250 basis points) immediately. Their model, similar to the Treasury one, predicts that we would have 0.25% more growth or an extra £4 billion of income and activity. That would be helpful. The only thing that seems to be stopping the cut in interest rates is the Monetary Policy Committee. Having resolutely got it wrong on the way up, with interest rates that were too low, they are clearly determined to get it wrong on the way down with interest rates that are far too high for too long.
In a democracy comment and criticism of the monetary authorites has to be part of the debate, especially when their actions are so important to our economic future and have had such an impact on our immediate economic past. Why doesn’t the MPC meet more often during the crisis? They clearly were not predicting all the extraordinary events we have seen in the last few weeks, so shouldn’t they earn their salaries by turning up for a few extraordinary meetings to get up to speed in the new circumstances? (Amended text after minutes of MPC published) We learn from the minutes that the MPC was summoned to a short extraordinary meeting instead of the usual two day affair. They were given a briefing by the Governor of the plan to have co-ordinated interest rate cuts, and given an update on the state of the eocnomy by the Bank in much more gloomy terms than their previous judgement. They then voted for the cut which the authorities clearly wished to co-ordinate with other governments. Whilst the government can claim the “independence” of the MPC has been shielded, this does not sound like a truly independent body coming to its own conclusions. Rather, it sounds like a body which had got it badly wrong was asked to start to make amends to fall into line with intergovernmental and inter Central bank thinking. If they were independent they would have stuck to their original timetable, or asked for a special meeting themselves and presented their own views on the economy.
Lower sterling makes us all worse off. It means higher prices of imports, which in current conditions means we buy less of them. Fortunately for commodities and energy the fall in the dollar prices still means prices are dropping in sterling terms. In order to rebuild confidence in our currency the government has to take more action to limit the downturn and to improve its own financial position. Yesterday’s debate on the troubles facing bsuienss going into the downturn was long on analysis but short on action commensurate with the problem. The Minister on duty talked about the odd million here and the odd million there on public spending. As the authorities seem to be seeking to withdraw more than £100 billion from private sector borrowing through their revised views on capital and prudence, these sums are tiny in comparison. The Credit Crunch began by troubling the banks. They will now pass the problem on to their customers, running down the lending and demanding repayment in some cases.